The perception that tighter sellside regulation has compromised significantly liquidity in the secondary corporate bond markets has no basis in fact, an analysis released by the International Organization of Securities Commissions (IOSCO) has determined.

“Based on the totality of information collected and analyzed, IOSCO did not find substantial evidence showing that liquidity in the secondary corporate bond markets has deteriorated markedly from historic norms for non-crisis periods,” the report, which was published in August, concludes. 

A total of 23 regulators and 73 financial firms responded to the IOSCO surveys. Of the total, 68% of the buyside respondents reported a perceived deterioration of liquidity between 2004 and 2015 while 80% from the sellside participants reported a perceived decrease in liquidity. The perceptions from the buyside and sellside, the report indicates, are generally based on personal experience and not supported with data or data analysis.

A number of traditional dealers say they have adjusted their business models to decrease the size of their balance sheets due to a combination of strategic, capital and regulatory factors. “Dealer corporate bond inventories are not keeping pace with the number of bonds available for trading in the secondary corporate bond markets,” the report points out. But rather than a sign of illiquidity, IOSCO’s finding indicate that this shift “may partially reflect the traditional dealers’ transition away from a principal model to an agency model, which does not require them to hold large amounts of corporate bonds on their balance sheets”.

According to several industry representatives and roundtable participants who contributed to the report, the roles of market participants are evolving, which has the potential to help mitigate a decrease in liquidity stemming from reduced traditional dealer market-making activity. 

The most significant examples are large asset managers, hedge funds, and independent market makers – such as non-bank affiliated firms – who are entering the market as not only liquidity takers, but liquidity makers. “This change in role is facilitated by electronic trading venues enabling greater ‘all-to-all’ trading across sellside and buyside market participants,” the report notes.

The industry representatives also indicate that smaller or regional broker-dealers or banks increasingly provide liquidity to the secondary corporate bond markets, with some of them focusing on certain industry segments (eg, technology, financial, energy etc.). This observation is also supported by a recent study conducted by Asset Benchmark Research, which showed that in Asia’s local currency bond markets, investors are relying more on local or regional banks to conduct their trades.

While electronic trading has been mooted as a way to offset traditional dealers’ shift to an agency model, the IOSCO study indicates that electronic trading venues are generally used for a limited range of standardized and frequently smaller transactions. “The use of electronic platforms varies across jurisdictions,” it says. “A few jurisdictions have experienced substantial growth in trading on electronic platforms while in others trading volumes on electronic platforms has been low, including in emerging markets.” 

IOSCO says it has not found evidence that the use of technology increases liquidity in the secondary corporate bond market, per se. The greater use of technology should lead to increased transparency. But the report says “there is a need to consider the impact of transparency on the liquidity that market participants are willing and/or able to provide”. 

Both the buyside and the sellside expressed the view that “too much” transparency, and in particular, realtime post-trade transparency, can negatively impact liquidity, including prices moving against a dealer when it attempts to offset positions taken.

IOSCO acknowledges the challenges in assessing liquidity across different countries and markets. Some have large and liquid corporate bond markets while others have small markets. “These variables make comparisons of the liquidity of the corporate bond markets in different jurisdictions particularly challenging, and underscores the risk of over generalization about liquidity conditions.”