Banks have decreased their market-making activities over the past year and expect further cutbacks in 2016 according to the European Central Bank.
The ECB’s December 2015 survey on credit terms and conditions in euro-denominated securities financing and over-the-counter derivatives markets said a considerable number of respondents indicated a fall in their market-making activities over the past year, especially for government bonds and high-quality corporate bonds, with expectations of a further decrease in 2016.
The central bank said the deterioration in market liquidity and functioning accelerated between September and November last year. The survey added : “Respondents’ confidence in their current ability to act as a market-maker in times of stress is strongest for government bonds and weakest for high-yield corporate bonds and asset-backed securities.”
Fewer banks characterised their ability to make markets in times of stress as good, and more banks characterised it as only moderate. “Results show a strong deterioration in respondents’ ability to act as a market-maker in times of stress, particularly for high-yield corporate bonds,” added the ECB.
Concerns have been raised that the incoming MiFID II regulations, covering financial markets in Europe, will further impact liquidity in the fixed income market by introducing pre- and post-trade transparency requirements.
Steven Maijoor, chair of the Esma, said in a speech last month that to define liquid bonds the regulator needs to obtain transaction data and reference data for each instrument before the number-crunching can even start and the same applies to other asset classes.
The legislative text says MiFID II is due to come into force in January 2017 but the European Securities and Markets Authority has asked for a delay of one year. The regulator’s request has to be approved by both the European Parliament and Council, which could happen this month.
The ECB survey also found that less favourable credit terms were being offered to counterparties across the entire spectrum of securities financing and OTC derivatives transaction types, in particular for hedge funds.
“Liquidity and functioning of markets has deteriorated for many types of euro-denominated collateral covered in the survey,” added the ECB. “Credit terms are expected to tighten further for all counterparties over the next three-month reference period, in some cases considerably.”
The maximum amount and the maximum maturity of funding in securities financing transactions have decreased for many types of collateral. The survey found increased use of central counterparties for securities financing transactions when government bonds, high-quality and high-yield corporate bonds, and covered bonds are used as collateral.
“Survey respondents reported an increase in the level of resources and attention devoted to the management of concentrated credit exposures to CCPs in particular,” said the ECB.
The Bank for International Settlements has also warned that a concentration of the risk management of credit and liquidity risk in CCPs may affect system-wide market price and liquidity dynamics in ways that are not yet understood, even though the shift to central clearing reduces counterparty credit risk.
In a report last month the BIS said: “At the end of 2014, two CCPs accounted for nearly 60% of the total volume of cleared transactions reported to the Red Book, a publication that compiles statistics covering centrally cleared transactions reported by members of the Committee on Payments and Market Infrastructures.”
In addition 83% of CCPs are directly owned or managed by the company operating the stock exchange.
As a result there are ongoing discussions on the financial strength of individual CCPs and on ensuring the continued provision of clearing services if a CCP goes into recovery or resolution.
The ECB survey is conducted four times a year and covers changes in credit terms and conditions over the three-month reference periods ending in February, May, August and November. The results are based on responses from a panel of 28 large banks, comprising 14 euro area banks and 14 banks with head offices outside the euro area.