Changes in core government bond markets over the past decade may have made them more prone to liquidity imbalances in times of stress. The severe dislocations experienced in those markets during the March 2020 turmoil were the outcome of large spikes in the demand for liquidity by various market participants, especially non-banks.
Unlike the typical case of being a ‘safe haven’ in periods of stress, government bond markets experienced a ‘dash for cash’ as investors scrambled to sell highly liquid assets to fulfil their cash needs. This included sales of bonds to meet redemptions and/or margin calls, as well as to unwind leveraged positions.
Bank dealers increased their trading activities to some extent, but this was not enough to counterbalance selling pressures. Other liquidity providers did not appear to sufficiently increase their intermediation activities, while the behavior of other market participants varied across FSB member jurisdictions.
Central bank interventions were effective in alleviating market strains, but they are not without cost and should not substitute for the obligation of market participants to manage their own risks appropriately.
The report outlines policies to consider for enhancing the resilience of core government bond markets, including measures to:
- mitigate unexpected and significant spikes in liquidity demand by non-bank investors. This involves assessing and mitigating factors that give rise to such spikes, e.g. liquidity mismatches, margining practices or the build-up of leverage.
- enhance the resilience of liquidity supply in stress. This involves exploring potential ways to increase the availability and use of central clearing for government bond cash and especially repo transactions, as well as the use of all-to-all trading platforms.
- enhance market oversight, risk monitoring and the preparedness of authorities and market participants. This involves increasing the level of transparency in government bond markets and closing some of the substantial data gaps identified in the report.
The FSB wrote: “To enhance the resilience of liquidity supply in stress, work could involve exploring further potential ways to increase the availability and use of central clearing for government bond cash and especially repo transactions, as well as the use of all-to-all trading platforms. However, as noted in the report, the scope, incentives and modalities of central clearing vary widely across jurisdictions and need to be considered for the specific market in question. In addition, the resilience benefits of expanding the use of all-to-all platforms depend on whether non-banks would be a stable source of liquidity in stress, which is not a given.”