Convertible or not: making sense of stresses in AT1 bonds market

Mahmoud Fatouh and Ioana Neamțu

Similar to the Deutsche Bank’s episode in 2016 and the Covid stress in 2020, AT1 spreads over subordinated debt rose rapidly and sharply following the Credit Swiss rescue deal. Beyond these three cases, AT1 spreads have been stable. In this post, we focus on conversion risk of AT1 bonds (also known as contingent convertible, CoCo, bonds) to explain the sharp rise in AT1 spreads in these three cases. Conversion risk is the main additional risk of AT1 bonds, compared to subordinated debt. It arises from the potential wealth transfer from AT1 bondholders to existing shareholders when AT1 conversion is triggered, conditional on the solvency of the issuer. We show that, in normal times, investors believe conversion risk is very low, but major events can change this significantly, largely due to higher uncertainty.

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Lifting the lid on a liquidity crisis

Lydia Henning, Simon Jurkatis, Manesh Powar and Gian Valentini

Autumn 2022 saw some of the largest intraday moves in gilt yields in history. It was then that jargon normally confined to financial stability papers entered into mainstream commentary – ‘LDI’, ‘doom loop’, ‘deleveraging’. And it was then that the Bank of England engaged in an unprecedented financial stability motivated government bond market intervention. What happened and why has been set out in detail in official Bank communications. This article instead hovers a magnifying glass over transaction-level regulatory data on derivative, repurchase agreements (repo) and bond markets to quantify liability-driven investment (LDI) and pension fund behaviour and enrich our understanding of these exceptional few weeks of stress.

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Funding structures and resilience to shocks after a decade of regulatory reform

Kristin Forbes, Christian Friedrich and Dennis Reinhardt

Recent episodes of financial stress, including the ‘dash for cash’ at the onset of the Covid-19 (Covid) pandemic, pressure in the UK’s liability-driven investment funds in 2022, and the collapse of Silicon Valley Bank in 2023, were stark reminders of the vulnerability of financial institutions to shocks that disrupt liquidity and access to funding. This post explores how the funding choices of banking systems and corporates affected their resilience during the early stages of Covid and whether subsequent policy actions were effective at mitigating financial stress. The results suggest that policy responses targeting specific structural vulnerabilities were successful at reducing financial stress.

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The gravity of cross-border syndication ties in financial services trade

Luke Heath Milsom, Vladimír Pažitka, Isabelle Roland and Dariusz Wójcik

Exports of financial services decline with geographical distance at a rate comparable to that for international trade in goods (eg, Portes and Rey (2005)). This is surprising since there are no transportation costs involved. The consensus is that distance is a proxy for information frictions. We show how cross-border syndication can help overcome information barriers to trade in financial services. We zoom in on the equity underwriting industry where international syndicates reduce information asymmetry between issuers and investors located in different countries.

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The challenges of measuring financial conditions

Natalie Burr

The challenge of measuring financial conditions

Imagine you were tasked with thinking about how financial conditions have changed over a policy tightening cycle. Different economists would come to very different conclusions, and none would necessarily be wrong. Why? Because measuring financial conditions is challenging – for a variety of reasons. A financial conditions index (FCI) is a common solution, and its advantage lies in the disadvantage of the alternative: it is simpler than making a judgement across a range of individual variables. In this post, I propose one method to create a UK FCI. I find that financial conditions have tightened significantly over the past two years, coming from a period of accommodative conditions following Covid.

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The effects of subsidised flood insurance on real estate markets

Nicola Garbarino, Benjamin Guin and Jonathan Lee

5.2 million properties in England are at risk of flooding. To ensure the availability and affordability of flood insurance to households in flood-prone areas, the UK Government introduced an innovative reinsurance scheme, Flood Re, in April 2016. It provides insurers with an option to pass the flood-risk element of their policies on to the reinsurer at a lower fixed price according to property council tax band. In a recently published Staff Working Paper, we employ a granular data set of all property transactions and flood events in England. We estimate the effect of Flood Re on property values. We also explore if Flood Re effects are heterogeneous across different subpopulations in England.

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‘There is all the difference in the world between paying and being paid’: margin calls and liquidity demand in volatile commodity markets

Gerardo Ferrara, Gerardo Martinez, Pelagia Neocleous, Pierre Ortlieb and Manesh Powar

The Russian invasion of Ukraine in February 2022 and subsequent sanctions led to unprecedented increases in key commodity prices. While prices briefly abated in late spring and early summer, these surged again over late July and August, with EU and UK gas prices reaching new peaks on 26 August. These moves created a sudden and significant demand for liquidity from market participants with derivatives positions. This post examines how non-financial firms (henceforth ‘commodity traders’) reacted to this liquidity pressure, and how their reactions impacted the functioning of commodity derivatives markets. Commodity derivative markets are important for the real economy and the recent events underscored the need to better understand the interdependencies between margin and counterparty risk management practices.

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Do larger bond trades cost more to execute?

Gábor Pintér

Are larger trades more or less expensive to execute in bond markets than smaller trades? This is an old and unsettled question in the literature on financial markets. The aim of this blog post is to provide novel answers to this question, based on our recent research using transaction-level data from the UK government and corporate bond markets, over the period 2011–17.[1]

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Strengthening the resilience of market-based finance

Naoto Takemoto, Simon Jurkatis and Nicholas Vause

In less than two decades, the system of market-based finance (MBF) – which involves mainly non-bank financial institutions (NBFIs) providing credit to the economy through bonds rather than loans – has both mitigated and amplified the economic effects of financial crises. It mitigated effects after the global financial crisis (GFC), when it substituted for banks in providing credit. But it amplified effects at the outbreak of the Covid pandemic, when NBFIs propagated a dash for cash (DFC), and more recently when pension fund gilt sales exacerbated increases in yields. This post outlines five different aspects of MBF that contribute to such amplification and summarises some policy proposals – suggested and debated internationally by regulators, academics and market participants – to make MBF more resilient.

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