When the Global Financial Markets Association, the bank lobby group, and the Institute of International Finance commissioned their 100+ page review on market liquidity, it was inevitable that the costs for end users, the issuers, were going to take centre stage.
Issuers, as the widget making, factory building, job creating real economy favourites, attract more political sympathy than traders or asset managers.
Access to funds for corporates is more obviously a concern for politicians and society than the inability of fund managers to beat their benchmark because they’re killed on the bid-offer, or the shrinking revenue pie in FICC divisions at investment banks.
But, actually, there’s an uneasy and complicated relationship between raising money in primary markets and passing securities around in secondary.
Classically, more liquidity is supposed to be good for both.
If investors know that there will be an available and liquid secondary market when they wish to get out of an investment, they ought to be willing to pay more for it.
This is the liquidity risk premium, and, if funding issuers as cheaply as possible is a Good Thing, it needs to stay small, especially after the exceptional monetary conditions of the last half-decade are eventually phased out.
That might be true, but liquidity is scarce on both the bid and offer sides, so finding decent clips means investors are turning to the primary market to get size. That means more engagement with issuers earlier on and more feedback to syndicate desks, which should, in turn, mean tighter spreads in primary.
Even if in a distant post-QE world the bull market in bonds falls away, that doesn’t mean big size secondary offers will suddenly be readily available.
Syndicate benefits
Since the crisis, the buyside has become more concentrated, and the likelihood of BlackRock wanting to exit a €200m position when Pimco wants to buy one has correspondingly diminished.
This is part of the worry about dealer balance sheets — that they can no longer intermediate this mismatch. But the shrinkage of inventories will tend to keep big buyside institutions coming back to primary markets.
Perhaps they will demand an illiquidity premium, but more likely, they will acknowledge that the whole market has become less liquid, and that staying invested is more important than throwing tantrums.
Thinner liquidity in secondary markets also raises the value of primary market staff. It’s already become commonplace among syndicate bankers to cite the last primary print in a particular asset class, rather than illiquid outstanding secondary curves, but this should also raise the returns to the syndicate desk itself.
If the outstanding secondary curve is clear and obvious, the syndication process is easier, and correspondingly less valuable to issuers. Any banker can look at secondaries, tack on a new issue premium and open books.
But when you can’t trust secondary levels, experience, market knowledge, good intelligence from investors, distribution experience from past deals, and good buyside relationships — not to mention the dark arts of syndication — come to the fore, and issuers will recognise the value in paying for quality.
As primary markets increase in importance relative to secondary, this also does self-fulfilling damage to secondary markets.
Busy days in primary, with plenty of deals on screen, mean investors and their sales coverage are concentrating on new issues, not on adjusting their existing portfolio. Primary issues might generate some secondary switching flow, plus associated hedging and swap business, but they take time investors and salespeople do not have to spare.
Primary and secondary markets also compete within banks for management attention, resources and balance sheet. Barclays wants to be “origination-led”, while plenty of other institutions are hiring private-side product bankers even as they fire credit traders.
Regulators are starting to pay attention to anxieties over liquidity, and are looking again at ways to make sure markets do not seize up. That is a commendable goal, and will hopefully lead to more joined-up, thoughtful regulation.
But primary markets should only give two cheers. Skinny secondary markets — or at least, skinnier markets than pre-crisis — are not an entirely bad thing for primary professionals and the issuers they serve.