Faultlines that were exposed when coronavirus shook corporate bond markets must be addressed to prevent future disruptions to a key source of funding for companies worldwide, according to the top organisation representing securities regulators.
The International Organization of Securities Commissions is examining ways to improve the overall functioning and liquidity of corporate bond markets, particularly in stressed conditions.
Central banks were forced to slash interest rates and restart huge emergency bond-buying programmes in March 2020 as turmoil spread across financial markets globally when governments rushed to impose lockdown measures to counter the spread of coronavirus.
“Orderly corporate bond market functioning is critical to the needs of the real economy. But the events of March 2020 raise questions about market functioning and whether improvements could be made to bolster liquidity,” Martin Moloney, secretary-general of Iosco, said in an interview.
Iosco on Wednesday issued a consultation paper and invited feedback from market participants by July 6.
The warning by Iosco comes amid mounting concerns that the multi-decade bull market for bonds, which dates back to 1981, has ended, with the Federal Reserve and other major central banks starting to raise interest rates in response to strong inflationary pressures.
Corporate bond markets have increased massively in size since the 2008-09 global financial crisis as ultra-low interest rates and reductions in lending by banks have encouraged companies globally to make more use of debt to finance their activities.
But liquidity, or the ability to trade without causing large price swings, remains a problem, with corporate bonds trading less frequently in most jurisdictions than stocks or government bonds.
Although trading activity on electronic platforms has increased, particularly in the US, activity in corporate bond markets remains heavily dependent on a small number of dealers that conduct private bilateral deals over the telephone with institutional investors.
However, traditional dealers did not step up to buy corporate bonds as prices fell during March 2020 when electronic trading activity also declined. Large withdrawals from fixed-income mutual funds added to the selling pressure as investors made a dash for cash in response to the rapid spread of the pandemic, Iosco said.
It noted that issuance of new corporate bonds effectively shut down in most markets for two weeks in early March 2020 which affected secondary market trading activity. Costs for buying and selling most bonds increased and liquidity challenges meant that larger trades became more expensive than transactions of smaller parcels of bonds, a reversal of normal practice.
“The events of March 2020 when there was a significant collapse in fixed-income liquidity suggests that corporate bond markets are not structurally strong,” Moloney said.
The disruption prompted the Federal Reserve to start buying corporate bonds for the first time which helped to calm the volatility. But the Fed and other central banks have now committed to scaling back and gradually reversing their bond-buying programmes. This shift, known as quantitative tightening, is adding to regulators’ concerns that corporate bond markets could be vulnerable to further disruption.
“Liquidity is inherently weak in corporate bond markets which may be unable to absorb significant and sudden increases in selling pressure. We must consider how best to reinforce the resilience of these key markets which are growing larger and larger,” Moloney added.