NY Fed findings say reforms including the Dodd-Frank Act and Basel III regulation have constrained banks in their ability to trade corporate bonds, leading to “adverse impact” on bond-level liquidity.
Source: Financial Times
Regulations designed to safeguard the US from another financial crisis have damped corporate bond trading activity, according to the Federal Reserve Bank of New York.
The findings, published in a blog post on Wednesday by the NY Fed and in the Journal of Monetary Economics, recognize that reforms including the Dodd-Frank Act and Basel III regulation have constrained banks in their ability to trade corporate bonds and has had an “adverse impact” on bond-level liquidity.
Asset managers and other “buyside” groups have complained that the depth of corporate bond liquidity — or the ability to buy or sell a bond without affecting its price — has declined as banks have reduced their balance sheets. At the same time, the overall size of the corporate bond market has swelled and is now worth more than $8.5tn, 75 per cent larger than its size before the financial crisis.
The paper’s authors Tobias Adrian, who has moved to the International Monetary Fund, Nina Boyarchenko and Or Shachar, note that “institutions more affected by post-crisis regulation are less able to intermediate customer trades”.
But the New York Fed maintains that while constrained dealers are less active in the market than they otherwise would be, overall liquidity in corporate bonds has not declined. The net value of corporate securities held by primary dealers, the financial institutions that help sell US government debt, has fallen to $23.2bn from a 2014 high of $45.9bn, according to New York Fed data.
Previous research from the New York Fed has argued “ample” liquidity in corporate bond markets remains despite shrinking balance sheets. The Federal Reserve has also previously published research on the impact of regulation on bank market making activities in times of stress.