What does the ECB rate hike mean for European secondary markets?
In July, the ECB raised interest rates in an attempt to curb surging borrowing costs, causing primary issuance to decline. What does this mean for European corporate debt? Dom Holland from of our Business Development team gives his thoughts on how secondary markets can use new technology to reform the risk transfer model.
By Dom Holland
In July, the European Central Bank raised interest rates for the first time in over a decade in an attempt to curb surging borrowing costs, as has the Federal Reserve. But unlike the Fed, the ECB is struggling under the weight of structural problems unique to the European Union that make economic and fiscal policy reform complicated. The EU is in its very nature a bundle of unique and diverse individual economies, all with their own historic challenges and various factors that impact their capacity to borrow – and at what costs?
What does this mean for European corporations? Or to be more precise, European corporate debt? Unlike in the United States, where companies still tend to access public markets during times of stress, European corporates tend to turn more to existing banking relationships for funding. This general trend means European primary issuance is declining at a rate that is even steeper than that of the US market. Issuing in both markets is expensive, but the fragmentation of the European market and more volatility in underlying government bonds means pricing issuances become even more difficult. In essence, the European situation mirrors that of the United States, only more severe.
So, what does this mean for the future? Corporate bond issuance in Europe will decline and trading will become more expensive and harder to execute. As primary issuance dries up, increased pressure will fall on secondary markets as asset managers look to rebalance portfolios as bonds mature and they need to reinvest proceeds. If there is no appropriate vehicle in the new issue market… well, they’ll turn to secondary markets, which are highly illiquid, and when you add the fuel of structural challenges to the fire, reinvesting becomes that much harder. This is one factor that is driving the increased flows in European bond ETFs, which comes with its own pros and cons.
This is why our work at LedgerEdge is so crucial to expand the addressable market. The traditional risk transfer model for fixed income investment is severely challenged in its ability to mitigate stress; a lack of liquidity means risk is simply moved around as traders use different vehicles, such as ETFs, to manage their portfolios.
At LedgerEdge, we’re using distributed ledger technology to find better ways of increasing unique opportunities across live markets and actionable liquidity by creating a better functioning market in bonds that don’t trade. Smart order contracts usher more traders into the market by preventing data leakage and limiting price impact by only showing their offers to traders with compatible bids, so traders can manage portfolios or their investment strategy improvements more efficiently. We hope building confidence in the structures behind trades encourages more activity and therefore more liquidity – thus reducing risk.
Using new technology to reduce uncertainty and create a smoother way to execute trades means we can de-risk the system and increase the market’s ability to weather stress as market paradigms change. We’re making this market a more level playing field. Don’t get left behind.