The possibility that European Union rules may harm fixed income liquidity was highlighted in responses to the EU Commission as it reviews the regulatory framework for financial services in the region.
Last October the EU Commission launched a Call for Evidence and requested comments by last month on the benefits, unintended effects, consistency and coherence of more than 40 pieces of legislation that has been adopted in direct response to the 2008 global financial crisis. The Commission said in a statement: “The Call for Evidence also presents an opportunity for respondents to consider holistically the last six or so years of European law-making across the financial services market and provide feedback accordingly.”
The International Capital Market Association said in its response that it had chosen to focus primarily on market liquidity, which affects the ability of the economy to finance itself and grow.
“ICMA wishes to highlight that it is important for policy makers and regulators to acknowledge that fixed income markets are very different structurally to equity markets,”said its response. “Essentially, unlike equities, bonds, as a distinct asset class, can and should be considered to be mostly illiquid.”
The association continued that a less liquid secondary bond market potentially widens the market spread for new issues and creates additional borrowing costs for issuers and harms the real economy.
ICMA said that all the elements needed for fixed income market-making are being seriously compromised by different pieces of regulation. The new Capital Requirements Directive has made balance sheet for banks and broker-dealers far more expensive and the provisions under the Fundamental Review of the Trading Book are expected to significantly increase the capital required for fixed income market-making. In addition Emir, the regulation covering central clearing, has raised the cost of, and restricted access to, credit default swaps which provide hedging for corporate credit risk and in addition repo market liquidity is becoming scarcer.
“Further regulatory initiatives, such as CSDR [Central Securities Depositories Regulation] mandatory buy-ins and MiFID II/R pre- and post-trade transparency requirements, may only serve further to render the market-making model economically unviable and obsolete,” added ICMA.
MiFID II, the incoming regulation covering financial markets across asset classes, requires trades in liquid bonds to meet certain pre-trade and post-trade transparency requirements. The regulator has supported an instrument-by-instrument approach for defining bond liquidity and is trying to collect data in order to determine which bonds should be classed as liquid instruments.
The Association for Financial Markets in Europe also warned in its response that if Europe wants to develop its capital markets, policymakers need to consider the impact of new regulation on banks’ ability to provide services.
“Regulatory reform – and in particular additional capital requirements – has already forced bank deleveraging resulting in a reduction in banks’ lending capacity and market-making capacity,” added the AFME. “For instance, European corporate bond trading volumes fell by up to 45% between 2010 and 2015, while dealer inventories have also declined significantly. Several major firms have also recently withdrawn from their primary dealer role in European sovereign bond markets.”
The Alternative Investment Management Association also highlighted the need for regulators to carefully consider the reform of market infrastructure to support liquidity. The AIMA also called for regulatory reforms to support non-bank finance in its response.
“AIMA makes the case that rules should allow greater asset managers’ participation in securitizations in order to support the supply of finance to small and medium-sized enterprises,” said its response. “AIMA also argues that greater holding of financial assets by institutions and investors that can bear risk without the need for public support - such as investment funds - will improve financial stability.”
The Investment Association also said in its response that its main concern is that regulation of banks and markets could impair the efficient functioning of financial markets. However the association added that the single market, fund passporting rights, the UCITS regime and a relatively harmonised single rulebook have all undoubtedly brought significant benefits to the UK's asset management industry.
The European Fund and Asset Management Association called for a realistic implementation timeframe in its response as deadlines which are too short can lead to legal uncertainty and cause serious challenges. Alexander Schindler, president of EFAMA, said in a statement: “There are currently many examples of fundamental directives affecting our industry (MiFID II , UCITS V, PRIIPs) where it is extremely difficult to be prepared within the prescribed timetables.”
MiFID II was due to be implemented in January 2017 but the European Securities and Markets Authority has requested a delay to January 2018.
Kay Swinburne, MEP and member of the Economics and Monetary Affairs Committee in the European Parliament, said in a speech to the Commodities Markets Council today that the Commission is expected to make a proposal for a one-year delay to MiFID II in the middle of this month.
“Esma needs more time to scope and build the IT system that will form the core of its supervisory system. They are about to embark on building one database of all financial instrument reference data,” added Swinburne. “However, the delay in implementation should not be interpreted as a lessening in regulatory zeal.”
Jonathan Hill, commissioner for financial stability, financial services and capital markets union at the EU Commission tweeted: “Call for evidence on financial legislation: nearly 300 responses so far, from all sections of the industry, public authorities and end users.”
The Commission is due to report on the responses by the middle of this year. The review is part of the Commission’s plan to launch a Capital Market Union across the EU. The Commission has set a 2019 deadline for completing CMU.
Featured image via iStock
