Speakers of the session
Has market volatility increased and liquidity declined?
Secretary General, Financial Stability Board (FSB)
Director General of Financial Stability and Operations, Banque de France
Philipp M. Hildebrand
Vice Chairman, BlackRock
Objectives of the sessionThe objective of this exchange of views is to discuss the current status and likely future trends of liquidity and volatility in EU capital markets, the impacts of fragile liquidity and increased volatility for issuers, investors and the market at large, as well as possible solutions for ensuring sufficiently resilient market liquidity.
Points of discussion
What is the current status of market liquidity and volatility, what are the related risks and the likely future trends?
- How significant are the current liquidity and volatility issues? What are the key areas of concern regarding certain instruments (e.g. corporate bonds) or types of orders (e.g. large orders)? Are liquidity risks increasing and are they appropriately priced?
- Does the current liquidity stress (liquidity shortage, bifurcation in certain asset classes) create financial stability risks in the market? What are the impacts for issuers and investors and more broadly the economy? Can volatility spikes create systemic risks also?
What are the main causes and drivers of the current volatility and liquidity trends?
- What is the importance of regulatory drivers for current liquidity trends compared to other possible drivers related to: the monetary environment or market-driven evolutions? What is the importance of cyclical vs structural factors? What are the connections between market liquidity and volatility?
- Can new upcoming or proposed regulatory measures (e.g. transparency requirements of MiFID II, FTT project…) further affect market liquidity? What are the prospects of market liquidity particularly in the bond market, with the on-going developments of monetary policy in the EU and US?
How to ensure sufficiently resilient market liquidity in normal and stressed market conditions and what should be the respective roles of the public authorities and the private sector in this regard?
- What is the likely impact of on-going changes in the trading area (e.g. electronic trading, changes in trading behaviour i.e. smaller tickets, more brokerage…) and to what extent can they help to improve liquidity? What are the likely future evolutions of market making and of its business model? To what degree are alternative players to traditional market makers stepping in? Could market makers return to the market in stressed market conditions, when spreads widen?
- How can the asset management sector help to better mitigate liquidity risks and what evolutions need to be considered in this perspective?
- What additional public-sector driven actions or measures may help to further prevent market liquidity risks in normal conditions and in stressed conditions? What are the most promising actions to improve market liquidity? What should be the respective roles of the public authorities and the private sector in this respect?
- Is the data available sufficient to assess market liquidity issues and identify possible remedies?
Background of the sessionLiquidity is a matter for concern in the market. There is a widespread perception that liquidity has decreased in many markets, particularly in the corporate bond market but also to a certain extent in government bond markets over the last few years and that dealer inventories are decreasing, while bond volumes issued and exchanged have been increasing. Signs of liquidity bifurcation have also been pointed out. Reduced liquidity may increase the volatility of markets and widen spreads (especially in volatile periods) and possibly challenge financial stability in case of market stress. Some observers however stress that pre-crisis liquidity levels should not be taken as a reference point given that liquidity was not appropriately priced at the time. The magnitude of current liquidity issues and the actual impacts for end-users are being debated and assessments are still underway. The data available to judge these issues is however still insufficient, some observers stress with e.g. a lack of real time data. A review of the functioning of bond markets by the EU Commission focusing on how market liquidity can be improved is planned as part of the CMU initiative for 2017.
Volatility is another concern, as it is increasing across asset classes and price impact spiked quite significantly at several moments in 2015.
Different structural and cyclical factors have been put forward to explain the current liquidity trends, although their precise impacts still need to be completely evaluated. Increased regulatory requirements are a first element, notably increased capital requirements for the banks acting as market-makers. Market-driven factors to be considered include changes in market structure (e.g. concentration of counterparties), investment behaviour (e.g. trading in smaller tickets, transactions that do not go through the market), the increase of secured bank funding leading to a reduction of available collateral. The current non-standard monetary policy (QE) may also impact liquidity notably by reducing the amount of available assets in the market. Technology is an important driver also both positive - reduction of trading costs and optimisation of the use of balance sheets with electronic trading – and negative – development of automated and algo trading which may lead to liquidity stress in some circumstances. Enhanced transparency for non-equity instrument transactions with the implementation of MiFID II may also have mixed effects some observers stress. There is moreover anxiety lest some regulatory developments such as the NSFR or the FTT proposal might further hamper liquidity.
Several changes under way could help to improve market liquidity. An increasing use of electronic trading can be observed and should continue with the implementation of MiFID II as well as the development of trading in smaller tickets. There are also significant evolutions under way in the asset management sector with changes in the manner portfolios are constructed (e.g. with back up sources of temporary liquidity) and more emphasis on liquidity risk management and stress testing. Other options are being considered, combining public and private sector initiatives, for further tackling liquidity issues over time, both in normal market conditions (e.g. modernisation of the fixed income market structure and “plumbing”, bond standardisation, further leveraging technology, clarification of the liquidity provision obligations of market-makers, further improvement and standardisation of fund structures, use of ETFs) and in stressed conditions (e.g. possible interventions of Central Banks as a backstop to support liquidity, further transparency provided by market infrastructures).