Various denominations of U.S. dollars and Mexican pesos are arranged for a photograph at a currency exchange in Mexico City, Mexico, on Friday, Oct. 10, 2014. Mexican bond returns have bolstered by the peso, whose 0.4 percent gain last week is the biggest since the period ended Sept. 19, data compiled by Bloomberg show. Photographer: Susana Gonzalez/Bloomberg
The dollar was a big beneficiary of the shift in sentiment on interest rates © Bloomberg

A report on deteriorating bond market trading conditions commissioned by two of the financial industry’s biggest lobbying groups has urged regulators to ameliorate the “liquidity” crunch by revisiting parts of the post-financial crisis supervisory framework.

The report, authored by PwC and commissioned by the Global Financial Markets Association and the Institute of International Finance — two lobbyists for international banks and money managers — largely blamed new banking industry regulations for the sharp downturn in bond trading.

The liquidity of global debt markets has emerged as a hot topic in the financial industry over the past year, with people including JPMorgan chief executive Jamie Dimon, Blackstone founder Stephen Schwarzman and economist Nouriel Roubini warning that it could cause or exacerbate a financial crisis.

Bonds have become harder to buy and sell in recent years, even as global debt markets have swelled and billions of dollars of retail money has gushed into fixed income vehicles such as mutual funds and exchange traded funds, which promise investors the ability to sell their investments almost instantaneously.

The concern is that if retail investors are burnt by losses they could pull their money out of funds that hold increasingly illiquid securities, exacerbating a sell-off and fuelling even more outflows. Fears have been growing as the US Federal Reserve is preparing to raise interest rates this year — perhaps as early as September — which is expected to result in bond market turbulence.

The PwC report said that more risk-averse banks — which have historically played a crucial, dominant role in lubricating bond market trading — have contributed to the liquidity crunch. But it indicated that the overhauled regulatory framework imposed on banks in the wake of the financial crisis had hamstrung their ability to act as market-makers, and is the main contributor to the trading slump. It therefore urged officials to review parts of the regulatory architecture.

“There are grounds for a review of the calibration of the reforms to date and the ongoing regulatory agenda, in order to properly understand and consider the effects of regulatory initiatives on market liquidity by asset class, and to consider whether upcoming regulatory initiatives could likely exacerbate the trends in liquidity,” the report argued.

It offered several suggestions on how to improve the situation, including better market data and analysis; exploring the links between liquidity and regulations; harmonising the global regulatory landscape; and rolling back policies that “may not add significantly to financial stability, but are detrimental to financial markets liquidity”.

The report constitutes another salvo from the financial industry against parts of its new regulatory framework. While many officials and policymakers have also expressed concerns over the decline in bond market liquidity, most have been unsympathetic to arguments that even parts of the overhauled global financial rule book should be tweaked.

Nonetheless, Kenneth Bentsen Jr, the head of the GFMA, said that PwC’s report showed that policymakers should at the very least study the cumulative impact of new rules imposed on the sector before introducing any further regulatory changes.

“A tremendous amount of regulation has already been implemented over the past five years in response to the financial crisis. While the intent to improve financial stability is entirely appropriate, regulators must also consider the impact to market liquidity,” he said.

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