Questions Q1 to Q12 of the Consultation paper - Recent financial market turmoil: evidence of market failures in the corporate bond market and lack of post-trade information available in this market

Questions Q1 and Q2 of the Consultation paper address the potential market failures:

Q1: Do you believe the situation described above may be symptomatic of a market failure?

1. Most of the respondents recognised the difficulties in the functioning of corporate bond markets over the previous months with a severe retreat of liquidity accompanied by widening of bid/offer spreads, reduced availability of information and difficulties in valuing positions. On such a common background, two different positions emerged:

a) on one side, some respondents argued that the reaction of bond markets from summer 2007 onwards has been a rational one and indicative of a proper functioning market. In other words, the developments show that the market works and the reactions are understandable and prove that the market has not failed. This was mostly the position of the sell-side representatives responding to the consultation;

b) on the other side, most of the respondents underlined how collectively the events may be perceived to be symptomatic of market failure. In particular, the initial retreat in liquidity was reflective of investors’ concerns over risk exposure and uncertainty on valuations. This had a spiraling effect whereby the disappearance of liquidity led to heightened investor concerns, fuelling a further retreat in liquidity. The self-reinforcing nature of these events was considered by some to be a symptom of a market failure in that the market mechanism was not able to equilibrate itself. This was the view of some buy-side respondents together with exchanges, entities representing investors and committees on market integrity.

2. Beyond the issue of transparency, one respondent highlighted the issue that the corporate bond market has demonstrated to be highly dependent on the capacity of dealers to ensure the function of market making and the problems in the market occur at a time where access to fixed income securities is most needed for issuers to fulfill their funding needs and for investors to actively manage their portfolios.

3. Some respondents did not consider themselves to be in a position to evaluate whether the situation may be described as a market failure but nevertheless considered the situation to be severe. Some of them, although not providing any response to the specific question, indicated post-trade transparency as one factor, among others, that could help restore market confidence.

CESR notes the difficulties in the functioning of corporate bond markets over the past months and considers that collectively the events may be perceived to be symptomatic of market failure. Therefore, in combination with other measures, CESR believes that additional post-trade transparency would be able to contribute to improving current market conditions in the corporate bond market. In addition, CESR also recognises the issues experienced by some market participants and specifically retail investors, small market participants and buy-side industry. CESR acknowledges that the current structure of the corporate bond market makes it highly dependent on the capacity of dealers to ensure the function of market making.

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