Addressing market liquidity: A broader perspective on today’s Euro corporate bond market
Vasiliki Pachatouridi, Director, Fixed Income Portfolio Management Group, BlackRock| Oct 2016
BlackRock has recently published a new ViewPoint on market liquidity, focusing specifically on European denominated debt, including corporate bonds, the second biggest corporate bond market globally after the US.
Liquidity in corporate bond markets continues to be a priority for regulators and investors around the world. However, market participants’ decisions are often based on what is known about the US fixed income market. “In our view it is important to evaluate European corporate bond market liquidity in the context of the European market structure,” says Vasiliki Pachatouridi, Director, Fixed Income Portfolio Management Group, BlackRock.
Here are five things to know about market liquidity and European fixed income markets:
European corporate bonds trade less than their US equivalents. This is mainly because the market is still small relative to the size of the economy and lacks a larger institutional investor base, as is the case in the US. For example, non-financial corporate bonds make up less than 10% of Euro area GDP versus 30% of GDP for the equivalent market in the US.
Additionally, the lack of consistent and reliable trade reporting data makes it harder to assess the true level of secondary market liquidity in Europe.
The European Central Bank continues its quantitative easing programme and is adding corporate bonds to the mix. This decision has driven the strong performance of European corporate bonds in 2016. Simultaneously, it has become more difficult and more expensive for private investors to find the bonds they need to buy, hence they are increasingly looking to invest internationally, mainly in higher yielding US denominated assets and emerging market debt.
Bid ask spreads are becoming less meaningful. Banks under the traditional broker-dealer model are less willing to intermediate and hold risk on their balance sheet. Instead they are moving towards a more riskless type of business model, where they get compensated for facilitating trades, often referred to as agency trading. Under this new regime, low and stable bid ask spreads are becoming less meaningful as a liquidity metric, given that investors typically have to sacrifice immediacy and delay the trade until the broker-dealer has found the other side of the market.
Market participants are adapting to structural and cyclical changes. The trading landscape and transparency in EU capital markets is evolving fast and in similar ways to the US. Among the most noteworthy changes is the rising popularity of alternative credit vehicles such as bond ETFs, and greater adoption of electronic trading in fixed income, including trading venue and protocols. In fact, according to a Greenwich survey, electronic trading of corporate bonds is estimated to be higher in Europe than in the US.
European investors have increased bond ETF adoption. European investors are buying bond ETFs at a record pace as they look for more liquid and standardized products that help them address liquidity challenges in fixed income markets. European listed bond ETFs represent $150 billion in AUM and 2016 has seen the fastest growth rate in global bond ETFs since 2012, with European and US markets tripling in size over the last six years.
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