IOSCO Examines Liquidity in Corporates Under Stressed Conditions

Traders Magazine Online News, July 2, 2019

John D'Antona Jr.

The Board of the International Organization of Securities Commissions published a report that examines the factors affecting liquidity in secondary corporate bond markets under stressed conditions.

The report, prepared by IOSCO´s Committee on Emerging Risks, examines how liquidity in secondary corporate bond markets tends to evolve when those markets experience stress. The report seeks to increase understanding of how stressed conditions may affect both bond and other financial markets and the financial system more broadly. The findings are drawn from a review of the literature on liquidity in corporate bond markets under normal and stressed conditions, an examination of past episodes of stress in corporate bond markets and discussions with a broad range of industry stakeholders.

The report notes that changes in the structure of secondary corporate bond markets have altered the way that liquidity is provided in these markets. These changes result from such things as post crisis regulations that have reduced the capacity of intermediaries to provide liquidity in secondary corporate bond markets; greater risk aversion on the part of intermediaries; the gradual introduction of electronic trading; and significant growth in the size of these markets resulting from central banks’ quantitative easing policies and low rates of return on other financial assets.

The report’s main findings include:

• The structure of corporate bond markets has evolved since the financial crisis, driven primarily by changes in the behavior of market intermediaries and in the supply of and demand for corporate bonds.

• A reduction in the capacity and desire of dealers to participate in corporate bond markets as principals could mean that future movementsin bond prices in times of stress will be more acute than before.

• Several characteristics of corporate bond markets should reduce the risk that strong price movements in bond markets will generate broader economic stress. These include effective liquidity management by issuers of corporate debt, reduced leverage and fewer leveraged players in the market than before the financial crisis, and the low frequency with which many corporations enter primary bond markets for financing.

• The willingness, resources and ability of market participants to provide sufficient demand-side liquidity to help stabilize markets will be critical factors in determining how corporate bond markets operate under stress.

• Mutual funds are unlikely to be a source of either considerable selling or price volatility under stress, particularly those funds with managers who have instituted strong liquidity management processes, including plans for operating under stressed conditions.

For more information on related topics, visit the following channels:

• Fixed Income