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Capital market activities (repo, market making…): regulatory impacts and future trends - Economic and monetary challenges

Less market making in Bunds so what?

By Metzger Jochen - Head of the Department Payments and Settlement Systems, Deutsche Bundesbank

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The market for German Bunds has traditionally been a highly liquid market. Trading takes place al-most exclusively on electronic platforms. Liquidity is provided by a multitude of very active market participants. Therefore, given the high degree of market depth as well as the mainly Futures driven character of the market as a whole, primary dealers who are obliged by contract to market making activities have never been established on an institutionalised basis. Sufficient liquidity could be en-sured anyway. However, recent trends have been impacting market participants i.e. also market makers in their ability to provide liquidity to the market. Post-crisis regulatory reforms, in particular Basel III Leverage Ratio requirements induced significantly increasing capital requirements for mar-ket making activities. Hence, there is evidence that some dealers may even have given up on their market making activities completely and are now focusing on more profitable business areas. A re-duced number of large tickets, higher volatility and increased failures of delivery may be seen as a proof for this.

In addition, unconventional accommodating ECB monetary policies created improved cash liquidity, but also concerns occurred that the recent Eurosystem Public Sector Purchasing Programme may “run dry” the market and by this also induce collateral scarcity effects. Possibly, sales on a larger scale by international institutional investors mainly from Asia may have compensated for Eurosys-tem’s purchases, so that these fears have not materialized yet. This may explain to some extent the gap between market participants’ qualitative perception of reduced market liquidity and to the quantitative evidence provided by liquidity indicators. In a forward looking perspective PSPP as well as Basel III may contribute to deterioration in European government bond liquidity. This has also been noticed by the Eurosystem. Bundesbank as its member is well prepared and has set in motion operations to ensure sufficient availability of high quality liquid assets by re-mobilising collateral via lending and repos including reverse repos in the context of Securities Lending Arrangements set up by the Eurosystem.