Buy-side agree EU CSDR buy-in regime will threaten bond liquidity

Asset managers have expressed concerns that the CSDR mandatory buy-in regime will impact liquidity and increase costs.

An impending mandatory buy-in regime under new EU regulation, which forces market participants to settle failed trades, will increase costs and threaten bond market liquidity, the buy-side has largely agreed.

A majority 75% of asset managers and pension funds expect a negative impact on bond market efficiency and liquidity when the buy-in regime comes into force in 2020 under the EU Central Securities Depositories Regulation (CSDR), according to a study from the International Capital Market Association (ICMA).

Buy-ins, which are presently used at discretion as they can create unpredictable costs, are used for market participants to manage settlement risk in the case of failed trades, as the buyer goes to market to source the bonds from another party.

Initiating a buy-in against a failing counterparty will become a legal obligation under the CSDR regime, with limited flexibility on timing to complete the process. The payment of the difference between the buy-in price or cash compensation must also be made by the failing trading entity.

ICMA found that the buy-side is particularly concerned about bearing the increased costs of widening bid-ask spreads and decreased liquidity, which may come about as liquidity providers adapt to the regime. It was highlighted that offer-side pricing across fixed income could be negatively impacted as liquidity providers adapt to the regime.

Specifically, ICMA said bid-ask spreads of all bond sub-classes are expected to more than double, with covered bonds and illiquid investment grade credit seeing the biggest impact. For absolute price, the impact is most notable at the lower end of the credit spectrum, with significant increases for emerging market, high yield, and illiquid investment grade corporate bonds.

“Corporate bond markets rely heavily on liquidity providers shorting bonds that they do not own. This has always been the case. Liquidity is already very challenging and getting even more so,” ICMA said summarising buy-side comments on the regime. “This regulation, in its current form, is likely to mean that banks will not short bonds. This would have a devastating impact on market liquidity, function and asset managers ability to service their clients effectively. It is worrying that many in a front-office, markets facing position know nothing or very little about this impending regulation.”

Other comments from buy-side participants included concerns around solving disputes on the mandatory buy-in and cash compensation price, the difference in pricing between quotes depending on where trades are settled, and the ability for market makers to manage balance sheets.

The study concluded that the industry has low awareness of the new measure, which will impact bonds settled in Euroclear, Clearstream and other central securities depositories within the European Union.