Liquidity assessment by money market instrument Money Market Instruments Repo Federal government securities Provincial government securities Corporate securities Securities Lending Federal government securities Provincial government securities Corporate securities Money Market Securities Federal government securities Provincial government securities Corporate securities
Illiquid
Somewhat illiquid
Liquid
Somewhat liquid
Not applicable
0% 0% 31%
0% 8% 38%
15% 69% 0%
77% 15% 0%
8% 8% 31%
0% 8% 8%
8% 0% 46%
8% 54% 8%
62% 15% 8%
23% 23% 31%
8% 8% 15%
0% 0% 31%
0% 46% 38%
92% 46% 8%
0% 0% 8%
6
Change in bond market liquidity over the last two years Bonds Government of Canada bonds
Reduced significantly
Reduced somewhat
Largely unchanged
Improved somewhat
Improved significantly
Not applicable
8%
54%
31%
0%
8%
0%
31%
54%
15%
0%
0%
0%
Canada Mortgage Bonds
38%
46%
15%
0%
0%
0%
NHA-MBS Provincial bonds Corporate bonds High Yield bonds
Change in derivative liquidity over the last two years Derivatives Long-term interest rate futures (e.g. CGB) Short-term interest rate futures (i.e. BAX futures)
Interest rate swaps-OTC Overnight index swaps-OTC Fixed-income options-OTC
Change in money market liquidity over the last two years Money Market Instruments Repo Federal government securities Provincial government securities Corporate securities Securities Lending Federal government securities Provincial government securities Corporate securities Money Market Securities Federal government securities Provincial government securities Corporate securities
Reduced significantly
Reduced somewhat
Largely unchanged
Improved somewhat
Improved significantly
Not applicable
0% 0% 0%
62% 69% 42%
31% 23% 17%
0% 0% 17%
0% 0% 0%
8% 8% 25%
8% 0% 0%
38% 54% 46%
31% 23% 15%
0% 0% 8%
0% 0% 0%
23% 23% 31%
0% 8% 8%
38% 62% 69%
62% 31% 15%
0% 0% 0%
0% 0% 0%
0% 0% 8%
9
Most important impacts of lower bond market liquidity 100%
Per cent of Responses
90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Asset prices are more volatile
Larger price impact
Very important
Lower trade sizes
Indicative quotes are a poor indicator of trading prices
Somewhat important
Lower total trading volumes
Longer trade execution
Sell Side
Buy Side
Higher transactions costs
Not important
10
Drivers for the reduction in fixed-income liquidity Significant driver
Driver
Insignificant driver
Not a driver
Basel III OTC derivatives regulations (clearing, margins and platforms) Volcker rule Changes in capacity or willingness of non-dealer market participants to arbitrage mispricing
54%
46%
0%
0%
15%
69%
0%
15%
23%
69%
8%
0%
31%
38%
23%
8%
Reduced dealer market making capacity
85%
8%
8%
0%
More stringent internal risk management practices
31%
31%
23%
15%
Changes in pre and post trade transparency Electronification of trading Growing presence of HFT Growing popularity of ETFs
15% 15% 8% 0% 31% 0% 0% 8%
46% 23% 23% 0% 46% 31% 31% 54%
15% 23% 38% 38% 15% 38% 38% 31%
23% 38% 31% 62% 8% 31% 31% 8%
Growing presence of foreign buy and hold investors
Substitution of derivative for cash exposure Uncertainty surrounding economic conditions Low interest rate environment
11
Key concerns from recent changes in liquidity 100% 90%
Per cent of Responses
80% 70% 60% 50% 40% 30% 20% 10% 0% Amount of liquidity available on an average day
Amount of liquidity available during market stress (e.g. periods of high price volatility or high uncertainty)
Very concerned
Increasing volatility in the amount of liquidity
Somewhat concerned
Increasing pro-cyclicality of liquidity
Not concerned
12
Impact on ability to fulfill funds/firms' mandate from reduced liquidity 60%
50%
40%
30%
20%
10%
0% Little impact
Easier to achieve mandate
More difficult to achieve mandate
Have adjusted to reduction in market liquidity
13
Impact of global factors on Canadian fixed-income liquidity 90%
80%
Per cent of Responses
70%
60%
50%
40%
30%
20%
10%
0% Specific to Canadian FI market
Specific to global fixed income markets
Part of a general trend in all global financial markets 14
Changes in variability of liquidity over the last two years 120%
100%
80%
60%
40%
20%
0% From minute-to-minute
From day-to-day More
From week-to-week The same
From quarter-to-quarter end
Less
15
Summary of Survey Findings Most Canadian fixed-income instruments have experienced a reduction in liquidity over the last two years (most pronounced in corporate bonds). Regulation and reduced dealer market making capacity have been cited as some of the most significant drivers of declining liquidity. Liquidity has become more volatile. Participants are concerned about the lack of liquidity during market events. The reduction in liquidity does not appear to be a Canada specific issue and is linked to a general trend in all global financial markets. 16
Findings Consistent with takeaways from BoC Conference Survey findings are consistent with the takeaways from the market participant panel on Changes in Liquidity Dynamics from the BoC co-sponsored Liquidity Risk in Asset Management Conference in Toronto (September 10-11, 2015).
What should be the right level of liquidity?
Comparing current liquidity conditions against 2006-07 may not be appropriate
Liquidity is more bifurcated – remains good in sovereign bonds and associated derivatives but has declined in corporate bonds:
Impacted the way that participants transact Mispricing caused by illiquidity provides potential opportunities for active managers with balance sheet capacity Liquidity risk has been transferred to some degree from the dealer to the investor How should credit spreads adjust to reflect the lower liquidity in some assets?
Growth in the relative size of bond mutual funds and ETFs has increased the price risk from redemption Bid offer spreads are not a good proxy for liquidity – depth of market is 17
Liquidity Metrics in the GoC Bond Market
Let’s get on the same page on market liquidity Market liquidity
The cost-effectiveness of trading with immediacy and in volume
THREE DIMENSIONS
Tightness Depth Resilience
Sources: Bank for International Settlements; Kyle (1985) and Stoll (1970).
the price of immediacy the price of volume the rate of recovery of tightness and depth after some event
19
Bond issuance in Canada is changing Net new security issues placed in Canada Annual data
Can$ billions 90 75 60 45 30 15 0
2009
2010 GoC
2011 NHA MBS
Sources: Statistics Canada and Bank of Canada (including calculations)
2012 Corporate
2013
2014
Provincial and municipal Last observation: 2014
20
Trading volumes continue to rise Trading volumes of Government of Canada instruments Annual data, 2015 volumes pro rata Can$ trillions 10
Contracts (millions) 20
8
15
6 10 4 5
2
0
0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 GoC bonds: 3 years and under (left scale)
GoC bonds: 3 to 10 years (left scale)
GoC bonds: over 10 years and RRBs (left scale)
10-year GoC futures (right scale)
Sources: Bloomberg, MTRS and Bank of Canada calculations
Last observation: 2015 pro rata
21
Foreign flows in Canadian bonds: historically high and slowing down External holdings of bonds issued by Canadian government entities Quarterly data
Can$ billions 400 350 300 250 200 150 100 50 0
2003
2004
Source: Statistics Canada
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015 Last observation: 2015 Q2
22
Trading activity by foreign bondholders increasing International transactions of Canadian public and private bonds Monthly data, solid line = sales to external regions; dashed line = purchases from external regions
Can$ billions 300 250 200 150 100 50
Jan-12
Jul-12
Jan-13
Jul-13
All countries Source: Statistics Canada
Jan-14
Jul-14
Jan-15
0 Jul-15
Non-OECD countries Last observation: July 2015
23
Average GoC liquidity historically good though recently worsened Liquidity measures for Government of Canada bonds Aggregated across all bond transactions; percentage of price Weekly data, 12-week moving average % of price
% of price
0.04
0.10
0.08
0.03
0.06 0.02 0.04 0.01
0.00 2010
0.02
0.00 2011
2012
2013
Price-impact proxy (left scale) Sources: CDS and Bank of Canada calculations
2014
2015
Bid-ask proxy (right scale) Last observation: 30 September 2015
24
Repo and bond markets work together Aggregate trading volume of GoC securities by transaction type Weekly data Can$ billions 300 250 200 150 100 50 0 2010
2011
2012 Cash volume
Sources: CDS and Bank of Canada calculations
2013
2014
2015
Repo volume Last observation: 30 September 2015
25
BoC securities lending much more frequent Government of Canada bonds lent by the Bank of Canada Monthly data Can$ billions 15
12
9
6
3
0 2006
2007
Source: Bank of Canada
2008
2009
2010
2011
2012
2013
2014
2015 Last observation: September 2015
26
Settlement fails also more prevalent Government of Canada bonds: settlement fails and value lent by the Bank of Canada Monthly data Can$ billions 15
Can$ billions 75 60
12
45
9
30
6
15
3 0
0 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Value of fails (left scale) Change of methodology by CDS on 1 May 2015 Sources: CDS and Bank of Canada calculations
Jul-15
Aug-15 Sep-15
Value of bonds lent (right scale) Last observation: September 2015
27
Dispersion along the yield curve is normal Deviations from relative value arbitrage relationship (RMS) Daily data, dotted line = average level since 1994
15 13 10 8 5 3 0 1994
1996
1998
Sources: DEX and Bank of Canada calculations
2000
2002
2004
2006
2008
2010
2012
2014
Last observation: 4 September 2015
28
Points for discussion How is market liquidity affected by…
What has been the impact (if any) of trends such as… Electronification Futurization
29
Appendix A
Canadian Fixed-Income Market Metrics
30
Metrics for 2.5% June 2024 bond Trading volumes Daily data, 5-day moving average
Deviations from relative value arbitrage relationship Daily data Can$ billions 4
bps 8 Richer
3
6
2
4
1 2 Jan-15
Mar-15
May-15
Cash market Sources: CDS and Bank of Canada calculations
Jul-15
0 Sep-15
0 Jan-15
Repo market Last observation: 2 September 2015
Mar-15
May-15
Sources: DEX and Bank of Canada calculations
Jul-15
Sep-15
Last observation: 16 September 2015
Liquidity metrics
Settlement fails and yield-to-maturity Daily data
Aggregated across all transactions; percentage of price Daily data, 5-day moving average
Can$ billions
% 2.0
% of price
5
0.20
0.80
4
1.5
0.15
0.60
1.0
0.10
0.40
0.5
0.05
0.20
0.0
0.00 Jan-15
3 2 1 0 Jan-15
Mar-15
May-15
Settlement fails (left scale) Yield-to-maturity (right scale) Sources: CDS, DEX and Bank of Canada (including calculations)
Jul-15
Sep-15
Value lent by BoC (left scale) Last observation: 16 September 2015
% of price
Mar-15
May-15
Price-impact proxy (left scale) Sources: CDS and Bank of Canada calculations
Jul-15
0.00 Sep-15
Bid-ask proxy (right scale) Last observation: 2 September 2015
31
D-SIBs financing activity is still growing The Big Six are net borrowers of securities Outstanding amounts on consolidated balance sheets, monthly data
Repo and cash securities lending Last observation: June 2015
32
Volumes at CanDeal are growing CanDeal yearly trading volume Can$ trillions 3.0
2.5
2.0
1.5
1.0
0.5
0.0 2010 Source: CanDeal
2011
2012
2013
2014 Last observation: 2014 33
GoC turnover Annualized Government of Canada bond turnover ratio By maturity, annual data
Ratio 50
40
30
20
10
0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Under 3 years Sources: MTRS and Bank of Canada calculations
3 to 10 years
Over 10 years Last observation: 2015
34
Appendix B
International Fixed-Income Market Metrics
35
Euro area bond price dispersion Deviations from relative value arbitrage relationship (RMS) Daily data bps 10
8
6
4
2
0 2005
2006
2007
2008
2009
2010 Germany
Sources: DEX and Bank of Canada calculations
2011
2012
2013
2014
2015
Italy Last observation: 9 July 2015
36
US trading range much higher than in Canada Excess daily trading range of U.S. 10-year notes over daily trading range of GoC 10-year notes Daily data 50 40 30 20 10 0 -10 -20 -30 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 U.S. 10 year vs. GoC 10 year Sources: Bloomberg and Bank of Canada calculations
20-day moving average Last observation: 28 September 2015
