A new report published today by the International Capital Market Association (ICMA) documents the performance of the investment grade secondary bond market in Europe during the last weeks of February through March and April 2020, as the COVID-19 pandemic caused levels of market volatility and dislocation surpassing those seen during the global financial crisis of 2007-2008. The report is based on market data as well as interviews and surveys of buy-side and sell-side market participants.
The European investment grade corporate bond market is a major source of funding for European and other international companies: there are estimated to be over 7,000 bonds in issue with a value equivalent to €5.65 trillion.
As the scale of the COVID-19 pandemic became clearer towards the end of February, and as countries began to go into lockdown, predominantly passive funds sold bonds as they reassessed the risk of company downgrades and anticipated fund outflows. The sell-off gained momentum in March as market participants moved to working from home or from disaster recovery sites, creating further technical challenges and exacerbating reduced liquidity and market efficiency. Over this period bid-offer spreads, a measure of underlying market volatility, widened considerably. While bid-offer spreads have narrowed since the height of the crisis they are still not at pre-crisis levels.
Market liquidity, the ability to buy and sell bonds, became severely impaired in mid March, and by 18 March, considered to be the lowest point of the ‘liquidity crisis’ some market participants report that the market had become dysfunctional. The ECB announcement of the €750 billion Pandemic Emergency Purchase Programme (PEPP) on 18 March was critical in ensuring that the European bond markets continued to function, restoring confidence in secondary markets and setting the scene for record-breaking issuance in the investment grade primary market over the following weeks.
Among its findings, the report indicates that during the peak of the crisis, participants resorted to voice trading when the market became too volatile and too illiquid for dealers to risk providing pricing across electronic platforms. While many banks did continue providing liquidity and market-making via voice or messaging, overall dealer capacity appears to have shrunk at a time when it was needed most. Large trading volumes were however recorded through electronic platforms, using different trading protocols, for example processed trading where a price is agreed on the phone or messaging and then ‘consummated’ on a system.
There was a sizeable but temporary increase in settlement fails during the height of the crisis. This is largely attributed to the operational challenges of the relevant teams transitioning to remote-working at a time when overall trading volumes were significantly above average. This increase in structural settlement fails has accentuated concerns in the market about the EU’s CSDR mandatory buy-in provisions, due to come into force in early 2021, and raises questions as to how this would have impacted the market had it been in place during the COVID-19 turbulence.
Martin Scheck, ICMA Chief Executive commented: ‘This crisis provides a clear reminder that despite increasing electronification of trading over the last few years, the role of market-makers in creating liquidity remains at the core of the secondary markets. Reducing the ability of market-makers to provide this service will inevitably impact market liquidity and efficiency, especially in times of market stress.”
Download ‘The European investment grade corporate bond secondary market & the COVID-19 crisis’