ICMA secondary credit market - PowerPoint Presentation

1. ICMA secondary credit market study:meeting the liquidity challengeAmsterdam, November 10th 2015Andy Hill

2. Corporate bond markets and the real economy“Corporate bond markets can be considered an important ingredient in economic growth, financial stability and economic recovery, particularly in the wake of the crisis. They provide a key capital funding flow to firms allowing them to expand, innovate, offer employment, and provide the goods and services societies demand.” - IOSCO, 2014, ‘Corporate Bond Markets: A Global PerspectiveICMA secondary credit market study

3. The current state and future evolution of the European investment grade corporate bond secondary market: perspectives from the marketICMA secondary credit market study

4. Key-themes coming out of the studyThe death of liquidityChanging business modelsMarket transparencyElectronification of the marketThe issuer perspectiveThe risks from future regulationThe next crisis?Meeting the liquidity challenge: re-liquefying the corporate bond marketICMA secondary credit market study

5. What do we mean by liquidity“Liquidity is the ability to get a price in any instrument, in any size, at any time.” - Fund managerMeans different things to different participants2002-2007 a liquidity bubble? [CDS/structured derivatives]Dynamic (market cycles and bond life cycles)Quantifiable? As much a state as a measure“The golden age of liquidity was a very brief period, and driven by leverage.” - Credit traderICMA secondary credit market study

6. The death of liquidity“The main issue facing the investment grade Eurobond markets today is the lack of liquidity.” -Fund managerOverarching themeBasel III capital requirements; leverage ratios; EMIR, VolckerMarket conditions (QE, low rates, low volatility, tight credit spreads)No markets in size: more agency broking (an excuse?)Corporate bond markets inherently not liquidICMA secondary credit market study

7. The market-making model for fixed incomeThe four key ingredients:Balance sheetA functioning and liquid derivatives marketA functioning and liquid repo marketExpertiseICMA secondary credit market study

8. The market-making model for fixed incomeBreaking the model:Balance sheetBasel III capital ratiosA functioning and liquid derivatives marketEMIRA functioning and liquid repo marketBasel III leverage ratio ExpertiseAttrition and ‘juniorization’ICMA secondary credit market study

9. Changing business models – broker-dealers“The sell-side used to give liquidity away for free; now, if the buy-side wants it, they should pay for it” - Credit trader Better balance sheet allocation and focus on risk-weighted return on capital Reduced inventories, more client/axe focused (commission based model?) More niche players / specialization Down-sizing and down-grading of bank broker-dealersICMA secondary credit market study

10. Changing investor behaviour“Investment managers may become driven more by liquidity considerations, rather than by valuations or investment strategies” - Fund manager Splitting orders Internalized liquidity Primary markets as source of liquidity Buy-and-hold (increased due diligence) Less liquid investments (‘hunt for yield’) More use of derivatives / ETFsICMA secondary credit market study

11. The issuers perspective“We have enjoyed good market conditions; there is a lot of cash around, it is difficult to be overly concerned” - Corporate issuerMarket has been good, but issuers becoming increasingly concernedSecondary markets help price primary issuanceSelection of banks to award lead manager mandates?Standardized issuance?ICMA secondary credit market study

12. The risks from future regulation MiFID II/MiFIR: pre and post trade transparency requirementsThe winners curse (the transparency paradox)Confusion between transparency and liquidityDraft RTS seem much better than originally feared“Transparency is fine for retail trades, but it will kill the wholesale market” - Credit analystCSDR: mandatory buy-insA solution looking for a problemThe end of short-sellingICMA CSDR Mandatory Buy-in Impact Study (Feb 2015)“Mandatory buy-ins will be the final nail in the coffin of market liquidity” - Credit traderICMA secondary credit market study

13. The next crisis?“This is a classic bull market; valuations have gone out the window” - E-platform providerA common thread in the various discussions with all participants is the inevitability of the meltdown in global credit markets.Regulation has shifted risk from banks to investors.While market cycles are nothing new, the common concern is that, largely because of regulation, financial markets have never been worse placed to deal with a sharp correction. A combination of larger bond markets, with fewer, larger investment firms, and a weakened capacity for bank intermediation, all makes for the perfect storm. While some see the lack of liquidity in the secondary markets as exacerbating any correction, others are more concerned about how a non-functioning secondary market could impede any return to normality.ICMA secondary credit market study – meeting the liquidity challenge

14. Re-liquefying the corporate bond market Electronification of the market Buy-side initiatives Issuer initiatives Better regulationICMA secondary credit market study – meeting the liquidity challenge

15. Electronification of the market“When liquidity does come back, there will be fewer people and more technology” - E-platform founderIncrease in use, and expected to grow with more entrantsImproved scope for connectivity and new protocols (‘all-to-all’ /‘buy-side-to-buy-side’)Big data to support more ‘intelligent’ broking models Virtual liquidity (or ‘liquidity sourcing’)A replacement for market-making? ICMA secondary credit market study – meeting the liquidity challenge

16. Re-liquefying the corporate bond marketBuy-side initiativesInternalized liquidityPrice-makersRedemption gates ETFs and derivativesBut: is it the responsibility of the buy-side? Issuer initiativesMore selective awarding of mandatesStandardized issuance (‘benchmarking’)But: is it the responsibility of issuers?Better regulationWinners and losers?Functioning and efficient markets a social goodConnection between market regulation and real economyICMA secondary credit market study – meeting the liquidity challenge

17. ConclusionThe interviews for this study suggest that the European investment grade credit market is a dramatically changing landscape. Liquidity, by most definitions, is rapidly evaporating, primarily as a result of financial regulation and extraordinary monetary stimulus. Banks and investors are adapting to the new environment, as are electronic intermediaries who are looking to provide possible solutions. Issuers, as yet, are relatively unaffected, but are becoming increasingly concerned.While a number of market led solutions are being discussed, at some stage the impact of regulation on market liquidity and efficiency will need to be considered, not least as the role of capital markets in supporting economic growth comes ever more into focus. ICMA secondary credit market study – meeting the liquidity challenge

18. ConclusionUltimately, if the challenges facing the corporate bond secondary markets are to be addressed and solutions found this will require the constructive and coordinated effort of all stakeholders: market-makers, investment managers, trading platforms and intermediaries, the issuers, and the various regulatory bodies and authorities. Functioning and efficient capital markets are a social good that support economic activity and growth. For those who provide, use, and oversee capital markets, this should be a collective responsibility.ICMA secondary credit market study – meeting the liquidity challenge

19. ICMA Secondary Market Practices Committee (SMPC) Open forum for sell-side and buys-side members active in the European high grade corporate bond market. Key functions:Agreeing best practice for the corporate bond secondary market. Maintaining and developing the ICMA Rules and Recommendations for the secondary market (‘The ICMA Rule Book’) to ensure that they remain relevant and consistent with regulatory requirements. Leading initiatives to improve corporate bond secondary market liquidity and efficiency.Providing a forum for discussing the likely impact of relevant regulation on secondary market practices, and for consolidating input and feedback in the regulatory consultation process. Three sub-committee working groups: (i) MiFID II/R WG; (ii) CSDR/Buy-ins WG; (iii) Electronic Trading WGICMA secondary credit market study – Annexes

20. About the author/presenterAndy Hill is a Director in ICMA’s Market Practice and Regulatory Policy group. For seventeen years he has been a repo and money-market trader, and for ten years he was an Executive Director at Goldman Sachs. He has also worked as a consultant in the Aid and Development sector, primarily based in Cambodia, and previously served on the Board of the Cambodian NGO Education Partnership in Phnom Penh while under a Goldman Sachs Public Service Fellowship. He holds a BSc (Hons) in Business Studies from Cass Business School and an MSc in Poverty Reduction and Development Management from the University of Birmingham.Email: andy.hill@icmagroup.orgICMA secondary credit market study - Annexes