July issue of the Monthly Report: strong growth in market for non-financial corporate bonds
According to the current issue of the Monthly Report, the market for bonds issued by non-financial corporations in the euro area has grown strongly in the past few years. According to the capital market statistics published by the European Central Bank, the volume of these bonds in circulation has risen since early 2011 to around €1020.4 billion, an increase of just under 50%. The report cites French firms, in particular, as being major issuers in the reporting period, with France being a country in which firms have traditionally been heavily reliant on the capital market for funding. Italian, German and Spanish corporates also contributed to market growth. Non-financial corporations are those firms which do not provide financial or insurance services.
Supply and demand both higher
According to the Bundesbank’s exports, this development is attributable at once to greater supply and greater demand for corporate bonds. They write that, in a market that has grown on the whole, it was particularly in some periphery countries where a host of non-financial corporations diversified their sources of funding during the crisis years by substituting bank loans with bonds. At that time, firms in countries that had been hit particularly hard by the sovereign debt crisis were finding bank loans hard to come by, or could obtain them only at unfavourable terms. By contrast, French and German firms’ choice of funding vehicle is more likely to have been motivated by the fact that funding terms in the corporate bond market were more favourable than bank lending rates.
The Bundesbank’s experts also write that demand for corporate bonds has been on the rise since August 2011, for several reasons. One, the falling interest rates on risk-free investments had sparked avid interest among investors. This was why yield-seeking institutional investors such as insurance companies and other financial intermediaries (eg investment funds) had been investing more and more heavily in corporate bonds. Lastly, the Eurosystem has been on the scene as a serious investor since it started to purchase corporate bonds in June 2016. Under its corporate sector purchase programme (CSPP), launched on 8 June 2016 in an effort to spur economic activity and impact positively on the trajectory of inflation, the Eurosystem has been able to purchase corporate bonds, albeit under a host of conditions – such as minimum ratings or residual maturities.
CSPP purchases could come with side effects
The Bundesbank’s experts additionally write that the CSPP created additional scope for issuing bonds, yet that possible unpleasant side effects had been tacitly accepted. One of these was a potential bias towards firms that are active on the capital market, which generally includes larger firms. They add that, in this manner, the Eurosystem influences firms’ funding opportunities more than it does using conventional monetary policy instruments.
In addition, they note, there are risks to the Eurosystem’s balance sheet; despite the envisaged risk mitigation measures, they are greater than those involved in typical refinancing operations with credit institutions. The experts add that potential price distortions in the corporate bond market were another one of the programme’s risks. Moreover, they see the Eurosystem, in being a creditor to firms, as also taking on a new role when changes to material terms and conditions for issuing a bond are adopted at creditors’ meetings. They point out in the report that this role could be at loggerheads with the principle that monetary policy should retain a maximum of neutrality, ie that it should not impact on a firm’s business policy.
Bond market could continue to grow
The Bundesbank’s experts also point out a further trend which could evolve into a risk to the stability and functional viability of the market. They observe that CSPP had led to an increase in the co-movement of bond yields of firms from various sectors. What this could be saying is that differences between individual bonds are becoming less relevant to investors, which could ultimately impair the efficiency of the capital markets and capital allocation. According to the Monthly Report, the risk needed to be analysed continuously from a central bank perspective.
The article points out some factors that seem to indicate continued growth in the corporate bond market going forward. One is that firms which tapped the market for the first time in the past few years could be encouraged to replace bank lending with bonds in the long run. In addition, according to the article, political efforts by the EU, such as moves to dismantle barriers to European bond market integration and to improve transparency between different sets of national rules, could support market growth.
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