FCA says bank rules have not hit bond market liquidity
By Huw Jones and David Milliken
LONDON (Reuters) - The ability of investors to buy and sell corporate bonds has improved, not declined, in recent years, a paper published by Britain's markets regulator said on Thursday, potentially undermining calls from banks for a regulatory pushback.
Bond markets' ability to absorb heavy selling has become a major topic of debate between banks and central banks since the markets began what were dubbed "taper tantrums" when the U.S. central bank first publicly discussed winding down unusually supportive policies in 2013.
With interest official rates still very low in economies such as Britain, bond prices, which move inversely to yields, have surged. Holding bonds for regulatory purposes and to serve customers, banks fear losses as bond prices return to lower, more normal levels.
Banks say that higher capital charges on bond inventories introduced since the 2007-09 financial crisis mean that it is no longer economic to hold the amounts of bonds needed to offer a market at all times to investors.
Britain's Debt Management Office told Reuters on Wednesday that it planned to reduce the average size of bond auctions this year, in order to encourage bidding from banks which were reluctant to hold large stocks of gilts.
The Financial Conduct Authority (FCA), in a discussion paper by two of its staff, said dealers in Britain held 400 billion pounds' worth of bond inventories in mid-2008, but that fell to 250 billion pounds at the end of 2014.
However, it said this did not imply less liquidity, adding: "If anything, the market has become more liquid in recent years."
The findings carry weight because the FCA is a member of the Bank of England's Financial Policy Committee, which has been scrutinising liquidity in bond markets.
The European Commission, separately on Thursday, asked EU regulators to rethink new bond market rules citing liquidity concerns.
Regulators globally, however, say so far the jury is out on whether they need to intervene by scaling back capital charges and that other factors, such as shifts to electronic trading, could be affecting liquidity.
"The regulatory interventions that have been introduced since the financial crisis did not result in less liquidity in normal times and did not result in liquidity being more 'flighty' when shocks of a mild nature hit the system," the FCA paper said.
The structure of the UK corporate bond market has not changed markedly in the last eight years, with 90 percent of trades done "off-exchange" or privately, the paper said.
Bank of England Governor Mark Carney also heads the global Financial Stability Board, which is due to report in coming months on its studies into bond market liquidity.
The FCA told asset managers in February they must review how they would cope with widespread redemptions or investors pulling out money en masse in stressed markets.
(Reporting by Huw Jones; Editing by Ruth Pitchford)
