Conflicting bank safety rules may be reducing U.S. bond market liquidity, a witness from the securities industry told a U.S. House panel Friday.
Randy Snook, an executive vice president at the Securities Industry and Financial Markets Association, appeared at a hearing on the structure of the fixed income markets organized by the House Financial Services Capital Markets Subcommittee.
He gave the requirement that banks hold a minimum level of high-quality liquid assets as an example of a well-intentioned rule that could backfire.
The highest-quality liquid asset category includes securities issued by the U.S. government, or guaranteed by the U.S. government.
When dealers scoop up high-quality liquid assets to meet new standards, that cuts down on the supply of high-quality liquid assets available for purchase, and the dealers than have to add higher-yielding collateral to compensate for the burden of holding all of those high-quality, but very low-yielding, liquid assets, Snook said.
The constraints may reduce banks’ interest in operating in the bond market, especially in times of stress, Snook said.
Principal trading firms, or firms that specialize in buying and selling bonds, may help make up for the banks that back away from the bond market, “but market depth has become more fleeting in general,” Snook said. “Moreover, less diversity in liquidity providers leads to less resiliency, particularly during stress periods.”
The U.S. Securities and Exchange Commission developed municipal securities market disclosure rules that are set to take effect in May 2018. The rigid procedures required by the rules could chase dealers away from municipal bond market and hurt liquidity in that market, Snook said.
Another witness, Alexander Sedgwick, who appeared on behalf of T. Rowe Price Associates Inc. and the Investment Company Institute, said simply determining how bond market liquidity has changed is difficult, and that it’s hard to separate the effects of regulations from the effects of low interest rates and other market conditions.
Commonly used measures paint a mixed picture of the state of liquidity in the Treasury market, Sedgwick said, according to the written version of his testimony.