European Union (EU) regulators are assessing the potential threat to the financial system that a run on fixed-income funds could pose when central banks change course on monetary policy.

The size of the asset management industry has “raised issues about what happens in the case of a reversal in interest rates” that prompts investors to pull out their money, said Steven Maijoor, head of the European Securities and Markets Authority (ESMA). Regulators “need to look seriously into this issue, collect the evidence, and understand as well as possible the risks,” he said.

“Redemptions played a role in the financial crisis,” Maijoor said in an April 24 interview in Riga, Latvia. “Asset managers coped quite well with the reversals in the values at that time, but there’s no guarantee of that in the future.”

Traders and regulators are increasingly expressing concern about the stability of fixed income markets in the wake of an October fluctuation in the value of U.S. Treasuries. Jamie Dimon, chief executive officer of JPMorgan Chase and Co., said that was a “warning shot” to investors that the next crisis could be exacerbated by a lack of liquidity.

Banks and other market players are pointing the finger at a combination of new financial regulations, such as capital and disclosure rules, and the low interest-rate environment.

The role of asset managers is “one element of the debate” over concerns about market liquidity, Maijoor said. “How the various pieces of legislation work together and impact financial markets—I think we need to closely watch that and closely monitor that.”


‘Right Calibration’

ESMA is looking at these issues in tandem with the European Systemic Risk Board, a group that monitors threats across the financial system, he said.

The regulator is finalizing technical rules for an EU market overhaul, known as MiFID II. Banks have warned that transparency requirements for bonds may further damage liquidity because they may be applied to too many debt products.

“If you have the right calibration of transparency you can make the market more successful and make it more liquid,” Maijoor said. “We fully understand the concerns of industry; transparency can harm liquidity.”

Regulators are also concerned about market liquidity at a global level. Mark Carney, chairman of the Financial Stability Board, said this month that the group of global regulators agreed to a work plan to identify risks to financial stability posed by bond markets.

“Market participants need to be mindful of risks of diminished market liquidity, asset price discontinuities, and contagion across markets,” Carney said in a statement to the International Monetary and Financial Committee dated April 18.

The Oct. 15 gyration, when Treasury yields fluctuated by almost 0.4 percentage point, was an “unprecedented move” that would have serious consequences in a stressed environment, according to Dimon.

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