Episodes of short-term volatility and liquidity stress across several markets over the past few years have increased concerns about the worsening of secondary market liquidity, in particular in the fixed income segment. ESMA’s report confirms the negative effects of both the financial and sovereign crises on market liquidity. However, the report also shows that under a supportive monetary policy environment, market liquidity seems to have improved in the European sovereign bond segment. ESMA analysed daily data for sovereign bonds for ten EU members from January 2006 to December 2016.
The increase in sovereign bond liquidity stands in contrast to the corporate bond sector, in which there have been phases of lower liquidity in more stressed periods. Measuring the liquidity of the sovereign bond market liquidity is of fundamental importance for market participants (for instance when hedging positions, correctly pricing other securities, etc.) and policy makers alike. Market liquidity plays a central role when issuing new debt, in the transmission of monetary policy and, more generally, in ensuring the orderly functioning of financial markets and financial stability. Entities with investments in sovereign bonds may be exposed to market liquidity risks; to be considered in entity-level stress testing and risk management.
In absence of regulatory data, ESMA based its results on a commercial dataset, which covers daily data for sovereign bonds for ten EU members from January 2006 to December 2016. The sample period captures liquidity developments across both stressed and more benign market conditions. The sample includes 2,680 sovereign bonds traded on the domestic MTS platform, of which 1,892 traded on EuroMTS.
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