Bank of England Report Outlines Bond Crisis Scenario
Central bank warns that heavy withdrawals from bonds could lead to cash hoarding, illiquidity, and a market breakdown.
A Bank of England report says the European investment-grade corporate bond market could reach the breaking point if investors collectively withdrew 1.3 percent of total assets.
In its highly anticipated report, Simulated Stress Across the Financial System: The Resilience of Corporate Bond Markets, the British central bank outlines a pattern of behavior that would lead to the breakdown in the European bond ecosystem.
Analysts for the bank suggest that when withdrawals exceed 1.3 percent, fund managers would begin hoarding cash to meet redemptions and hedge funds would likely fail to supply liquidity for bond buying and selling.
The report also finds that in times of high market stress, bond market intermediaries, such as investment banks, would be less willing or able to intermediate markets when redemptions exceeded 0.9% of total assets. However, bank analysts acknowledge that this threshold could be as high as 2.4% of assets in periods of low market stress.
The level of redemptions at which corporate bond market dislocation occurs is determined by the ability and willingness of dealers to intermediate markets, which is assumed to vary with market stress, the report notes. If the dealer is exposed to significant market volatility when redemptions occur and expects to incur losses, the dealer is more likely to reduce its risk appetite and its provision of market intermediation services to the extent that even moderate levels of redemptions and asset sales could overwhelm the market capacity to absorb them.
The Bank of England report made reference to a run on United Kingdom real-estate funds in July 2016, after fund management groups put a temporary ban on withdrawals from institutions overwhelmed with redemption requests in the wake of the Brexit vote....MORE