23 April 2020 Issue Brief

Bond Market Liquidity

Market liquidity is a market's ability to facilitate the purchase or sale of an asset without causing drastic change in the asset's price. So, an asset's market liquidity describes an asset's ability to sell quickly without having to reduce its price to a significant degree. Bond market liquidity therefore refers to the market liquidity of bonds.

The corporate bond market plays a critical role in the U.S. economy. Businesses tap the bond market to raise more than $1 trillion in financing each year, and the more than $8 trillion of corporate bonds outstanding represent an important asset class for a variety of investors. 

Recently, liquidity conditions in the corporate bond market have become a concern to some, however. But the corporate bond market, in contrast to the U.S. Treasury bond market, is highly diverse with tens of thousands of distinct securities. Accordingly, liquidity differs in the corporate bond market. While certain bonds trade frequently, many rarely trade. Although there have been reports of periods during which liquidity conditions have been challenging, the corporate bond market has always been less liquid than many markets.

The corporate bond market liquidity debate is complicated and controversial. Technological developments, regulator actions, and macroeconomic forces have all been cited as causes of deteriorating market quality. Others argue that market quality has not deteriorated at all. The International Organization of Securities Commissions (IOSCO) joined the debate with the August 2016 release of a report titled Examination of Liquidity of the Secondary Corporate Bond Markets.  Other recent papers on the topic include the Bank for International Settlements (BIS) March 2016 report titled Hanging up the phone - electronic trading in fixed income markets and its implications and the International Capital Market Association’s (ICMA) Remaking the corporate bond market, a  July 2016 study of the European secondary corporate bond market, which is an important topic in the European Union’s ongoing Capital Market Union (CMU) agenda, which aims to improve the effectiveness of EU markets in allocating capital.

In order to contribute to this debate, CFA Institute developed a member survey on the issues surrounding bond market quality. The members surveyed were a pool of 3,881 volunteer CFA Institute members with a declared interest in capital markets issues. The response rate was 13.2% with 513 members participating. The results of the survey are captured in our September 2016 Secondary Corporate Bond Market Liquidity Survey.

The survey’s most striking results can be summarized as follows. Respondents from AMER and EMEA reported that over the last five years they have observed:

  • A decrease in the liquidity of highyielding and investmentgrade corporate bonds and no change in the liquidity of government bonds;
  • A decrease in the number of active dealers making markets;
  • An increase in the time taken to execute trades and a lower proportion of bonds being actively traded;
  • A higher proportion of unfilled orders.

These respondents also noted that bank capital and liquidity regulations have had a significant impact on bond market liquidity and that the focus of policymakers should be on removing impediments to the smooth functioning of institutional wholesale markets.

Respondents from APAC report that over the last five years they have observed:

  • No change in the liquidity of highyielding corporate bonds but an improvement in the liquidity of investmentgrade corporate and government bonds;
  • An increase in the number of active dealers making markets;
  • No change in the time taken to execute trades and a higher proportion of bonds being actively traded;
  • No change in the proportion of unfilled orders.

These respondents also indicated that there is no single factor that has had a very significant impact on bond market liquidity. They identified encouraging retail investor participation as a more important policy priority than improving institutional wholesale market functioning.

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