Asset managers are becoming more exposed to disruption in secondary credit market liquidity as investment banks reduce their exposure to volatility in the bond markets, according to a report from Moody’s Investors Service.
The report suggested that concerns around bond market volatility means that asset managers are facing a higher exposure to disruptions through revenue and reputational risk compared to banks and insurance companies. However, these financial institutions are in a position to absorb a decline in market liquidity, the report said.
Managing director of Moody’s Marc Pinto said: "Asset managers' fees are dependent on asset price levels and they could see a significant drop in revenue if there is a sustained decline in secondary bond market liquidity."
He added: "On top of that, there's reputational risk if fund structures that have to meet daily capital calls find themselves in a stress scenario with diminished ability to attract new assets and, in a tail scenario, to deliver fund proceeds."
According to the report, concerns around the bond market have been largely driven by regulations designed to reduce banks’ leverage, which have limited their propriety trading and market-making activities.
As corporate bond exposures have shifted from the banking sector towards asset management, the associated risks have been passed to both institutional and retail investors. The report showed that mutual funds and exchange-traded funds currently hold about a quarter of the US corporate bonds outstanding, compared to the pre-crisis figure of 13 percent.
Pinto also noted the more recent market volatility. He said: "During the market plunge at the end of the summer, we saw irregular price-setting in the ETF market which spooked investors."
"Increased volatility in the bond market could renew those concerns and lead to anxiety about the performance of funds invested in illiquid asset categories, especially bank loans and high yield corporate bonds."
Despite this, however, the report suggested that US financial institutions are prepared to cope with secondary market disruptions. In the Federal Reserve’s Comprehensive Capital Analysis and Review ‘severely adverse’ distress scenario, trading and counterparty losses for the five largest banks were between 4 and 5 percent of their gross market value.
