BlackRock Inc., the world’s biggest provider of exchange-traded funds, said bond market liquidity won’t return to levels seen before the 2008 financial crisis, and it’s time to move from complaining about poor trading volumes to creating solutions.
Among tools proposed Friday in a paper by New York-based BlackRock: fixed-income ETFs, blamed by some in the industry for creating an illusion of liquidity when the underlying assets may be hard to sell.
“Is there a story to bond ETFs contributing to the problem? No,” Mark Wiedman, head of BlackRock’s iShares ETF unit, said in a telephone interview. “They are contributing to the solution, I think we can say that with 100 percent confidence.”
Investors have been pouring into the products that bundle securities and trade like stocks, attracted by the simplicity and low cost of getting into markets that traditionally weren’t readily accessible. Fixed income ETFs on average trade four to five times more frequently than the underlying bond market, BlackRock said in the paper.
Some market participants have questioned whether the flow of money into such products will create issues once markets slump and money is being pulled. Gibson Smith, chief investment officer of fixed income at Janus Capital Group Inc., said last month that proposing ETFs or derivatives as solutions for illiquidity in the bond market could be exacerbating the problem.
BlackRock, which manages $4.77 trillion for clients, argues that trading in ETF shares adds a layer of price discovery. Its iShares unit offered more than 700 ETFs globally as of Dec. 31, with more than $1 trillion in assets.
“Bond ETFs actually add liquidity to the market because they trade on the secondary market,” said BlackRock co-founder Barbara Novick.
The firm also proposed that funds improve disclosure of liquidity risks and get greater freedom to handle redemptions, including imposing “out of the money gates,” paying back large institutional investors in kind rather than cash, and using short-term borrowing to meet redemptions. BlackRock reiterated a call for more bond trading to move to electronic platforms and away from dealers.
“Liquidity risk management has been part of portfolio management kind of since the beginning of time,” and investors have already adjusted their behaviors, Novick said.
BlackRock has written four papers in as many years on liquidity, suggesting fixes including more venues where dealers and customers can trade with anyone; increased standardization of new bonds to pool liquidity; revamping how traders offer and accept prices; and promoting behavioral changes for all market participants.
Bankers, regulators and investors have complained that the ability to buy and sell in the bond market without impacting the prices of securities has deteriorated in the aftermath of the 2008 credit crisis.
Some blame new regulations that have made it more expensive or difficult for banks to hold bonds on their balance sheets, but those rules aren’t going away, according to Richie Prager, BlackRock’s head of global trading.
“We don’t think we’re going back in time,” he said. “This is a new paradigm.”