Canadian Fixed- Income Forum...Canadian Fixed- Income Forum Toronto, 7 October 2015 Market Liquidity Survey Results 1 1 Survey results represent the views of the Forum’s private

Liquidity in the Canadian Fixed-Income Market

Canadian Fixed-Income Forum Toronto, 7 October 2015

Market Liquidity Survey Results1

1 Survey results represent the views of the Forum’s private sector members.

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Most important market liquidity attributes

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Speed of executionSize of bid-askspread

Average trade sizePrice impact of atrade

Available marketdepth

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Liquidity assessment by bond instrument

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BondsIlliquid Somewhat

illiquidSomewhat liquid

Liquid Not applicable

Government of Canada bonds GoC Benchmark (on-the-run bonds) 0% 0% 8% 92% 0% GoC Non-benchmark (off-the-run bonds) 8% 8% 77% 8% 0%Canada Mortgage Bonds 0% 31% 23% 46% 0%NHA-MBS 23% 54% 15% 0% 8%Provincial bonds 0% 23% 31% 46% 0%Corporate bonds 15% 46% 38% 0% 0%High Yield bonds 54% 31% 0% 0% 15%

Liquidity assessment by fixed-income derivative type

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DerivativesIlliquid Somewhat



Long-term interest rate futures (e.g. CGB) 0% 8% 23% 62% 8%Short-term interest rate futures (i.e. BAX futures) 0% 0% 23% 69% 8%Interest rate swaps-OTC 8% 8% 15% 54% 15%Overnight index swaps-OTC 15% 8% 23% 23% 31%Fixed-income options-OTC 31% 15% 23% 0% 31%

Liquidity assessment by money market instrument

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Money Market Instruments Illiquid Somewhat



RepoFederal government securities 0% 0% 15% 77% 8%Provincial government securities 0% 8% 69% 15% 8%Corporate securities 31% 38% 0% 0% 31%Securities LendingFederal government securities 0% 8% 8% 62% 23%Provincial government securities 8% 0% 54% 15% 23%Corporate securities 8% 46% 8% 8% 31%Money Market Securities Federal government securities 8% 0% 0% 92% 0%Provincial government securities 8% 0% 46% 46% 0%Corporate securities 15% 31% 38% 8% 8%

Change in bond market liquidity over the last two years

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BondsReduced significantly

Reduced somewhat

Largely unchanged

Improved somewhat

Improved significantly Not applicable

Government of Canada bonds GoC Benchmark (on-the-run bonds) 8% 54% 31% 0% 8% 0% GoC Non-benchmark (off-the-run bonds) 31% 54% 15% 0% 0% 0%

Canada Mortgage Bonds 38% 46% 15% 0% 0% 0%NHA-MBS 15% 62% 0% 15% 0% 8%Provincial bonds 15% 77% 8% 0% 0% 0%Corporate bonds 62% 38% 0% 0% 0% 0%High Yield bonds 31% 54% 0% 0% 0% 15%

Change in derivative liquidity over the last two years

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Derivatives Reduced significantly

Reduced somewhat

Largely unchanged

Improved somewhat


Long-term interest rate futures (e.g. CGB) 0% 31% 46% 8% 8% 8% Short-term interest rate futures (i.e. BAX futures) 0% 54% 31% 8% 0% 8% Interest rate swaps-OTC 8% 46% 23% 8% 0% 15% Overnight index swaps-OTC 15% 31% 8% 8% 0% 38% Fixed-income options-OTC 8% 31% 23% 8% 0% 31%

Change in money market liquidity over the last two years

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Money Market Instruments Reduced significantly

Reduced somewhat

Largely unchanged

Improved somewhat


RepoFederal government securities 0% 62% 31% 0% 0% 8%Provincial government securities 0% 69% 23% 0% 0% 8%Corporate securities 0% 42% 17% 17% 0% 25%Securities LendingFederal government securities 8% 38% 31% 0% 0% 23%Provincial government securities 0% 54% 23% 0% 0% 23%Corporate securities 0% 46% 15% 8% 0% 31%Money Market Securities Federal government securities 0% 38% 62% 0% 0% 0%Provincial government securities 8% 62% 31% 0% 0% 0%Corporate securities 8% 69% 15% 0% 0% 8%

Most important impacts of lower bond market liquidity

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Sell Side Buy Side

Higher transactions costs

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Asset pricesare morevolatile

Larger priceimpact

Lower tradesizes

Indicativequotes are apoor indicator

of tradingprices

Lower totaltrading

volumes

Longer tradeexecution

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Very important Somewhat important Not important

Drivers for the reduction in fixed-income liquidity

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Significant driver

Driver Insignificant driver

Not a driver

Basel III 54% 46% 0% 0%OTC derivatives regulations (clearing, margins and platforms) 15% 69% 0% 15%Volcker rule 23% 69% 8% 0%Changes in capacity or willingness of non-dealer market participants to arbitrage mispricing 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 15% 46% 15% 23%Electronification of trading 15% 23% 23% 38%Growing presence of HFT 8% 23% 38% 31%Growing popularity of ETFs 0% 0% 38% 62%Growing presence of foreign buy and hold investors 31% 46% 15% 8%Substitution of derivative for cash exposure 0% 31% 38% 31%Uncertainty surrounding economic conditions 0% 31% 38% 31%Low interest rate environment 8% 54% 31% 8%

Key concerns from recent changes in liquidity

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Amount of liquidity availableon an average day

Amount of liquidity availableduring market stress (e.g.

periods of high price volatility or high uncertainty)

Increasing volatility in theamount of liquidity

Increasing pro-cyclicality ofliquidity

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Very concerned Somewhat concerned Not concerned

Impact on ability to fulfill funds/firms' mandate from reduced liquidity

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Little impact Easier to achieve mandate More difficult to achievemandate

Have adjusted to reduction inmarket liquidity

Impact of global factors on Canadian fixed-income liquidity

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Specific to Canadian FI market Specific to global fixed income markets Part of a general trend in all globalfinancial markets

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Changes in variability of liquidity over the last two years

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From minute-to-minute From day-to-day From week-to-week From quarter-to-quarter end

More The same Less

Summary of Survey Findings

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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.

Findings Consistent with takeaways from BoC Conference

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

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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).

Liquidity Metrics in the GoC Bond Market

Let’s get on the same page on market liquidity

19 Sources: Bank for International Settlements; Kyle (1985) and Stoll (1970).

The cost-effectiveness of trading with immediacy and in volume

Market liquidity

Resilience

Depth

Tightness

THREE DIMENSIONS

the price of immediacy

the price of volume

the rate of recovery of tightness and depth after some event

Bond issuance in Canada is changing

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0

15

30

45

60

75

90

2009 2010 2011 2012 2013 2014

Can$ billions

GoC NHA MBS Corporate Provincial and municipal

Net new security issues placed in Canada Annual data

Last observation: 2014 Sources: Statistics Canada and Bank of Canada (including calculations)

Trading volumes continue to rise

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Contracts (millions) Can$ trillions

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)

Trading volumes of Government of Canada instruments Annual data, 2015 volumes pro rata

Last observation: 2015 pro rata Sources: Bloomberg, MTRS and Bank of Canada calculations

Foreign flows in Canadian bonds: historically high and slowing down

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400

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Can$ billions External holdings of bonds issued by Canadian government entities Quarterly data

Last observation: 2015 Q2 Source: Statistics Canada

Trading activity by foreign bondholders increasing

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300

Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15

Can$ billions

All countries Non-OECD countries

International transactions of Canadian public and private bonds Monthly data, solid line = sales to external regions; dashed line = purchases from external regions

Last observation: July 2015 Source: Statistics Canada

Average GoC liquidity historically good though recently worsened

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0.00

0.02

0.04

0.06

0.08

0.10

0.00

0.01

0.02

0.03

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2010 2011 2012 2013 2014 2015

Price-impact proxy (left scale) Bid-ask proxy (right scale)

Liquidity measures for Government of Canada bonds Aggregated across all bond transactions; percentage of price Weekly data, 12-week moving average

Last observation: 30 September 2015 Sources: CDS and Bank of Canada calculations

% of price % of price

Repo and bond markets work together

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100

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2010 2011 2012 2013 2014 2015

Can$ billions

Cash volume Repo volume

Aggregate trading volume of GoC securities by transaction type Weekly data


BoC securities lending much more frequent

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3

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9

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15

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Can$ billions

Government of Canada bonds lent by the Bank of Canada Monthly data

Last observation: September 2015 Source: Bank of Canada

Settlement fails also more prevalent

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45

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Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15

Can$ billions

Value of fails (left scale) Value of bonds lent (right scale)

Government of Canada bonds: settlement fails and value lent by the Bank of Canada Monthly data

Last observation: September 2015 Sources: CDS and Bank of Canada calculations Change of methodology by CDS on 1 May 2015

Can$ billions

Dispersion along the yield curve is normal

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5

8

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13

15

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Deviations from relative value arbitrage relationship (RMS) Daily data, dotted line = average level since 1994

Last observation: 4 September 2015 Sources: DEX and Bank of Canada calculations

Points for discussion

How is market liquidity affected by… Banking regulations Low interest rates and low-for-long Post-trade transparency Changing investor types (e.g. foreign buy-and-hold investors) Repo market functioning

What has been the impact (if any) of trends such as… Electronification Futurization

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Appendix A

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Canadian Fixed-Income Market Metrics

Metrics for 2.5% June 2024 bond

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1

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Jan-15 Mar-15 May-15 Jul-15 Sep-15

Can$ billions

Cash market Repo market

Trading volumes Daily data, 5-day moving average


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6

8


bps

Richer

Deviations from relative value arbitrage relationship Daily data

Last observation: 16 September 2015 Sources: DEX and Bank of Canada calculations

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0.5

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%

Settlement fails (left scale) Value lent by BoC (left scale)Yield-to-maturity (right scale)

Settlement fails and yield-to-maturity Daily data

Last observation: 16 September 2015 Sources: CDS, DEX and Bank of Canada (including calculations)

Can$ billions

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0.80

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0.20


% of price % of price

Price-impact proxy (left scale) Bid-ask proxy (right scale)

Liquidity metrics Aggregated across all transactions; percentage of price Daily data, 5-day moving average


D-SIBs financing activity is still growing

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500

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2008 2009 2010 2011 2012 2013 2014 2015

Reverse repo and cash securities borrowing Repo and cash securities lending

The Big Six are net borrowers of securities Outstanding amounts on consolidated balance sheets, monthly data

Last observation: June 2015 Source: Banks' regulatory filings (M4)

Can$ billions

Volumes at CanDeal are growing

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0.0

0.5

1.0

1.5

2.0

2.5

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2010 2011 2012 2013 2014

CanDeal yearly trading volume

Last observation: 2014

Can$ trillions

Source: CanDeal

GoC turnover

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Ratio

Under 3 years 3 to 10 years Over 10 years

Annualized Government of Canada bond turnover ratio By maturity, annual data

Last observation: 2015 Sources: MTRS and Bank of Canada calculations

Appendix B

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International Fixed-Income Market Metrics

Euro area bond price dispersion

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0

2

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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

bps

Germany Italy

Deviations from relative value arbitrage relationship (RMS) Daily data

Last observation: 9 July 2015 Sources: DEX and Bank of Canada calculations

US trading range much higher than in Canada

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-30

-20

-10

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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 20-day moving average

Excess daily trading range of U.S. 10-year notes over daily trading range of GoC 10-year notes Daily data

Last observation: 28 September 2015 Sources: Bloomberg and Bank of Canada calculations

U.S. Treasury liquidity (New York Fed)

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Canadian Fixed- Income Forum...Canadian Fixed- Income Forum Toronto, 7 October 2015 Market Liquidity Survey Results 1 1 Survey results represent the views of the Forum’s private

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