Half of 20 banks responding to an ECB survey reduced their covered bond market-making activity in 2016, the worst net result in the four years the survey has been conducted. The ECB nonetheless characterised banks’ ability to act as market-makers in time of stress as “relatively strong”.

Market participants – including the ECB official responsible for implementing CBPP3 – have cited a decline in market-making activity as one of the factors contributing to a loss of liquidity in the covered bond market in recent years.

The European Central Bank on 25 January published its December 2016 survey on credit terms and conditions in euro-denominated securities financing and over-the-counter derivatives markets (SESFOD), a quarterly exercise in which it gathered feedback from 28 large banks between September and November of last year. Alongside the questions posed in its quarterly surveys, the central bank has in its last four December exercises asked special questions relating to market-making activities to gauge longer-term trends.

The SESFOD survey – which overall took in 28 large banks, 14 in the euro area and 14 headquartered outside it – found that 43% of banks reported a decrease in their overall market-making activities for debt securities over the past year, while none reported an increase. The reduction was most pronounced in covered bonds, government bonds and convertible securities – as in the previous year.

Of 20 banks answering a survey question on covered bond market-making, 45% said their institution’s activities had decreased somewhat over the past year and 5% (i.e. one institution) said they had decreased considerably. 10% of respondents said their covered bond market-making activities had increased somewhat, and none said they had increased considerably. The remaining 40% said their activities had remained basically unchanged.

The ECB noted the difference between the percentage of respondents reporting decreases and those reporting increases – the “net percentage” – was a 40% decrease. This is the worst net outcome in the four years of the survey, after a net 27% decrease in the December 2015 survey and net increases in market-making activity reported for 2013 and 2014.

Asked in the latest survey how their market-making activities for covered bonds are likely to change in 2017, 20% of respondents said they are likely to decrease somewhat. Some 65% said they are likely to remain unchanged, 10% said they are likely to increase somewhat, and 5% said they are likely to increase considerably – giving a net decrease of 5%.

The respondents that expect their market-making activities to decrease this year cited as being among the most important possible reasons: the availability of balance sheet or capital at their institution; the willingness of their institution to take on risk; and compliance with current or expected changes in regulation.

Those that expect their market-making activities to increase cited the growing importance of electronic trading platforms, the availability of balance sheet or capital at their institution, and the willingness of their institution to take on risk.

The ECB said respondents’ confidence in their ability to act as a market-maker for covered bonds in times of stress was “relatively strong” for covered bonds, based on some 26% saying their ability to act as a market-maker in times of stress is good, 37% said moderate, 32% limited, and 5% very limited. The ECB came up with a net percentage of 26%, calculating the difference between the percentage of respondents reporting very limited or limited, and those reporting moderate or good. Nineteen banks answered this survey question.

The December 2016 results show respondents’ confidence to be almost unchanged from the previous December, when 28% of respondents said their ability to act as a market-maker in times of stress was good, 39% moderate, 21% limited, and 6% very limited, for a net percentage of 33%.

Of those who said in the 2016 survey that their ability is limited or very limited, 25% cited the willingness of their institution as one of the top three most important reasons, 25% cited the profitability of market-making, 17% cited constraints imposed by internal risk management, 17% the availability of hedging instruments, 8% their availability of balance sheet or capital, and another 8% selected “other”.

The quarterly survey found a 4% net decrease in the liquidity and functioning of the covered bond market over the quarter, based on 21 responses and with 10% saying it had deteriorated somewhat, 5% increased somewhat, and 86% remained basically unchanged. This was almost unchanged from a 5% net decrease the previous quarter but the sixth consecutive quarter in which liquidity was deemed to have declined, with a 35% net decrease recorded in the April 2016 survey marking a low.

The survey can be found by clicking here.

Photo: ECB/Flickr