US market significantly outperforming Europe
A study by Professor Avinash Persaud highlights for the first time the economic damage to Europe from competitive restrictions applied to wholesale trading in European government bond markets.
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The study, entitled “Improving efficiency in the European government bond market” analyses data from the eight main EU member states where the restrictions apply. The author calculates that Europeans suffer an estimated economic welfare loss of €119 million annually, as well as creating unnecessary systemic risks, hampering market liquidity and undermining trading-process innovation.
Commenting on the study, Professor Persaud stated “When it comes to market functioning, the US government bond market today significantly outperforms the European market – by all measures of liquidity, cost efficiency and volumes. Although European debt issuance is fragmented, restrictions on the location of trading are holding-back market development. These government-imposed restrictions may in fact create artificial liquidity and systemic fragility.” Persaud added, “One must ask how long Europe is prepared to accept electronic trading volumes 95% down from the US figures – when Europe’s potential exceeds the US by 37% in terms of bonds outstanding.”
The competitive distortions which result in these outcomes arise from government-imposed restrictions on banks (“primary dealers”) seeking participation in the primary government bond market. The restrictions are applied to secondary market trading, and effectively require primary dealers to execute government bond trades on designated electronic trading platforms.
The motivation for the restrictions is to centralize liquidity in a single location. However, experience in non-restricted markets demonstrates that dealers routinely aggregate prices from several sources onto one screen. This enables price discovery in one trading venue to inform another, ensuring multiple trading venues no longer fragment liquidity.
In this regard, the study supports the April 2003 second Giovannini Group Report, which called for a removal of secondary market restrictions and obligations for primary dealers in the European cash government bond market, and the May 2006 European Commission report on “Competition in EU securities trading and post-trading - Issues Paper” which further questioned the national restrictions placed on some primary dealers.
The study concludes that restrictions in European government bond trading, clearing and settlement deliver questionable benefits in terms of liquidity, raise systemic concerns and are a substantial cost to consumer welfare. Integration and development of national government bond markets in Europe will best be achieved through establishing a platform neutral regulatory framework.