BOE Orders Further Study of Market Volatility, Role of Dealers

The Bank of England’s Financial Policy Committee has called for further study of liquidity in corporate bond markets and the impact of changes in dealers’ ability to act as intermediaries.

The FPC, set up in 2013 to monitor and reduce systemic risk to the U.K. financial system, said there is evidence that turnover in over-the-counter markets such as for corporate bonds has fallen, along with a decline in the average trade size. Market-making dealers account for more than half of the gross amount traded in pound-denominated corporate debt, easing trades by final investors, the FPC said in a statement on Friday.

“Since the crisis, however, the role of dealers has changed,” the FPC said. “With transaction volumes unaffected, inventories have been worked harder; at the same time, inventories appear to have become less responsive, and prices more responsive, to sales of securities by other investors.”

Sudden price shocks in markets in recent years have raised concern that liquidity in markets worldwide has suffered as banks, eager to conserve capital, have focused market-making on a smaller set of highly liquid stocks, to the detriment of investors’ ability to buy and sell other securities. The growing importance of automated trading strategies in electronic markets has added to concern that the overall result of the increased use of those approaches may be amplifying price moves.

The FPC also said that a survey of 17 asset management firms covering 143 investment funds carried out by the BOE and the Financial Conduct Authority showed that investors staying in a fund aren’t disadvantaged when redemptions occur.

“This reduces incentives for investors to redeem if they suspect others will do the same,” the FPC said. “These funds also operate with minimal amounts of borrowing.”

The survey was carried out after the FPC asked the BOE and the FCA to analyze the risks to the financial system posed by mutual funds that allow their investors to redeem at short notice. The FPC asked for more work to be done on the potential impact of correlated behavior by investment funds, and on the steps those funds would be able to take if they found themselves under stress.

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