Corporate bond markets are becoming increasingly important to the real economy, raising a new set of risks and opportunities as those markets grow and evolve, says a new report from the research department of the International Organization of Securities Commissions (IOSCO).
IOSCO’s research department issued a new staff working paper, which does not reflect the views of IOSCO or regulators, that examines the development and functioning of corporate bond markets globally. It finds that the market has become much more important to the economy in the wake of the financial crisis, as corporate bonds are filling a gap left by bank and long-term/infrastructure financing, and showing potential for servicing small medium enterprises too.
“While financial firms in developed markets are deleveraging, non-financial firms are tapping the corporate bond markets in growing numbers. Bank lending to non-financials is weak in the U.S. and Europe, suggesting a move away from bank lending towards corporate bond financing in some developed markets,” it says.
Indeed, the report finds that the volume of corporate bond issuances has increased steadily to almost US$3.2 trillion in 2013, compared to US$0.9 trillion in 2000. And, these markets are growing in emerging markets, too, it finds. in the last 13 years, 27 new economies have recorded corporate bond issuances, mostly in emerging markets. Emerging markets accounted for 30% of issuance volume in 2013, up from just 5% in 2000, it says.
This growth in corporate bond markets is driven by a search for yield in a low return environment, the report notes. And, it suggests that as the interest rate environment shifts, this “may modify bond risks and raise new investor protection issues, especially from a retail investor perspective.”
The report also notes that before the crisis, corporate bond markets were awash with ‘phantom liquidity’, which was provided on the back of practices that were potentially systemically risky. Now, due to regulatory changes, this phantom liquidity has decreased, “creating higher liquidity risk for investors.”
“Eventually, greater liquidity risk will be reflected in higher yields and push up the cost of borrowing on corporate bond markets,” it says. “In this context, the report notes, electronic trading platforms could offer a channel for reducing liquidity risk.”
Ultimately, the report also suggests that changes in the secondary markets may transform the primary corporate bond markets. “Issuing firms may issue standardized issuances to facilitate electronic trading and/or continue to issue tailored bonds to meet specific financing needs. This could result in a segmentedmarket similar to listed equity and private equity markets; or standardized and over-the-counter derivative markets,” it says.
The report says further research on secondary market transformation is needed to disentangle the issue of ‘phantom liquidity’ and to distinguish trends in ‘real’ liquidity.
“The report is a good example of IOSCO being proactive and ahead of the curve in its research efforts. Corporate bond market development globally is important for long-term investment and economic growth,” said IOSCO chair, Greg Medcraft.