European Bond Market Became ‘Dysfunctional’ During March

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A new report published 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.

As COVID-19 became more widespread and countries went into lockdown, there was a market sell-off, which 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 widened considerably - these have narrowed since then but are still not at pre-crisis levels.

Market liquidity became severely impaired and by 18th March (the lowest point of the "iiquidity crisis" some market participants report the market as 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.

At 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. Many banks continued to make markets via voice or messaging, but overall dealer capacity appears to have shrunk at a time when it was needed most. Large trading volumes were however recorded through e-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, which was 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.

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."

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