Waiting for the ECB orders to pour in.

Photographer: Chris Ratcliffe/Bloomberg

ECB Risks Trashing Corporate Bond Liquidity

Mark Gilbert is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was London bureau chief for Bloomberg News and is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”
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The European Central Bank's quantitative easing isn't having the desired effect. Consumer prices dropped by an annual 0.1 percent in March, according to figures released Thursday, leaving the bank's 2 percent inflation target a distant dream. ECB President Mario Draghi's credibility is on the line.

So, starting now, the bank plans to increase its monthly bond buying to 80 billion euros ($91 billion) from 60 billion euros, and will add corporate debt to its purchasing list sometime later this quarter. But in the same way that the existing government bond program has destroyed price discovery in European sovereign debt, the inclusion of company debt risks trashing liquidity in that already sclerotic market.

Given the collapse in government borrowing costs since the ECB started pumping money into the markets -- QE has helped drive German 10-year yields down to 0.16 percent, compared with a five-year average of 1.4 percent -- companies have been quick to realize that the appearance of a buyer-of-first-resort in their market is an opportunity to fill the coffers with cheap cash.

The week that ended on March 18 (the same week Draghi announced his new measures) saw a record 23 billion euros of new corporate bond sales. In March there were almost 50 billion euros of total sales, the third highest monthly total on record. And money is getting cheaper as well as more plentiful. Sanofi, France's biggest drug maker, borrowed 500 million euros for three years earlier this week. The interest rate it's paying, of just 0.05 percent, is the lowest ever in the currency for a non-financial company, according to data mining by my Bloomberg colleague Katie Linsell.

So it's a great time to be a borrower. Being a lender, though, gets trickier all the time, as a combination of factors (mostly to do with bank regulation) conspires to sap the trading liquidity that investors depend upon to be able to manage their portfolios.

A freshly minted corporate bond used to trade for about 60 weeks after it was issued, until reaching a long-term investment home such as a pension fund, according to data compiled by Commerzbank. A year ago, that had dropped to about 45 weeks; since then, turnover has collapsed to about 25 weeks, as the following chart illustrates:

Source: Commerzbank

Turnover has collapsed as European banks have pared their trading activities. The two most active managers of new corporate bond issues in Europe are Barclays and HSBC, each with a market share of a bit more than 7 percent. Here's what Barclays has done to its balance sheet in the past two years:

And here's how HSBC has curtailed its activities:

Banks have typically been willing to commit capital to their corporate bond divisions as a way of winning other, more lucrative business from company treasurers. If I've helped you with your general fundraising, the thinking went, you're more likely to hire me when you decide to buy a rival; the juicy fees in mergers and acquisitions compensate for the poor returns in underwriting new bond sales. But as Swiss bond brokerage firm Bridport & Cie detailed in a recent report on liquidity, those days are over:

Bond trading has always provided a relatively low return for banks given the amount of capital required. Therefore, of all trading desks, bond trading desks have seen the greatest reduction in the amount of capital committed to them. Screen prices are increasingly unreliable, which has impacts for portfolio valuations. Most screen prices are modeled; the spreads are only updated when a position trades.

In other words, not only is it harder to find buyers and sellers of bonds when you need them, it's also more difficult to know the value of what you already own. Trading desks that have curbed their enthusiasm for fixed income aren't posting reliable prices on electronic systems.

The total size of the market that will be eligible for ECB buying -- rated investment grade, denominated in euros and issued by a euro zone company that isn't a bank -- is about 600 billion euros, according to data compiled by Bloomberg Intelligence analyst Jonathan Tyce. Once central bank traders start sweeping up those securities, liquidity problems in the debt markets can only get worse.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Mark Gilbert at magilbert@bloomberg.net

To contact the editor responsible for this story:
Marc Champion at mchampion7@bloomberg.net