Liquidity in the covered bond market is very different from a year ago and “limited”, according to the ECB official responsible for implementing CBPP3, with a “surprising” lack of primary issuance and the decline of market-making cited as factors in the deterioration in conditions.

In a panel at a European Covered Bond Council plenary in Düsseldorf on Wednesday, market participants agreed that liquidity in the covered bond market has become more limited in recent years. Moderator Steffen Dahmer, executive director – global product manager for covered bonds, JP Morgan, opened the discussion by asking participants for their take on conditions in the market.

“Liquidity in covered bonds is, let’s say, limited,” said Aaron Baker, global markets research at BBVA, “especially if you look at what has happened in the last two years.”

Conception Alonso, principal portfolio management expert, DG Market Operations, European Central Bank – who is in charge of the co-ordination and implementation of CBPP3 and the corporate sector purchase programme (CSPP) – agreed that liquidity conditions have deteriorated.

“My take on liquidity is that it is certainly different from one year ago,” she said. “In particular, I would agree with Aaron and say that it has become limited – both in the secondary and primary markets.”

Many market participants have suggested that the main driver of decreasing liquidity has been the ECB’s third covered bond purchase programme (CBPP3).

“Obviously there is a big potential buyer in the covered bond market that is by definition buy-and-hold,” said Alonso, “but we are not the only one, as we see that the investor base in covered bonds has changed, and more and more investors on the buy-and-hold side are in covered bonds, and that is also affecting liquidity conditions.”

She said a relative lack of issuance is a contributing factor, with the primary market a catalyst for secondary market liquidity.

“If we just go back to one year ago we were seeing a lot of issuance in the primary market with issuers competing,” said Alonso, “and this year, at this point in time, primary market issuance is extremely subdued, and that is contributing to liquidity conditions.

“The lack of primary market activity is surprising when you look at the current market conditions. Spreads levels are very favourable, there is still some relative value compared to government bonds, for instance, in particular in this quarter, and there is still investor demand.”

Alonso acknowledged that the lower levels of supply in recent months have been attributed to a frontloading of supply in the first half of the year and to attractive funding alternatives, namely the ECB’s TLTROs – which other panellists agreed is having a negative impact on issuance volumes.

Alonso noted that liquidity constraints are not confined to the covered bond market.

“One of the main reasons is the lack of market-making,” she said, “which I think everybody will agree with, and that is not specific to the covered bond markets only.”

Alonso added that the ECB has not changed its approach to buying covered bonds on the secondary market.

“Obviously what you get as offers very much depends on what is available in the market, so if liquidity conditions are tight then you will see less offers,” she said.

Asked by Dahmer whether the ECB would now take even Eu2m tickets, while Eu10m had tended to be the minimum in previous years, Alonso said this depends on the jurisdiction and on the issuer.

“We do not provide statistics on the ticket size,” she said, “but, for instance, the ECB published in its Monthly Bulletin at the beginning of August some analysis on the CSPP showing that most trades are of less than 10 million. If we were to compare the three purchase programmes, for instance in the corporate sector ticket sizes are often smaller than in the covered bond sector on the secondary market.

“It’s not as if ticket sizes have reduced substantially in the covered bond market.”