Corporate Bond Secondary Market Scheme (UK)

The purchases were expected to assist market-making by banks and dealers, to reduce liquidity premia on high quality bonds, and therefore remove obstacles to corporate access to capital markets. The Scheme was also expected to complement purchases of commercial paper under the CPF (Bank of England, “Market Notice: Asset Purchase Facility,” 2009).

In each auction, the Bank was restricted to buying no more than £5 million of each bond, depending on the amount of the issuer’s outstanding debt. Though that amount was relatively small, the frequency of the auctions, which at the beginning of the Scheme occurred four times a week, was intended to signal to bond holders that they could sell bonds if necessary. The Bank believed that this would lower the interest rates that counterparties charged for holding corporate bonds (Benford et al. 2009).

Purchasing small quantities of corporate bonds also aligned with the MMLR framework, which the Bank specified involved transacting in “modest quantities” (Fisher 2010). Purchases through the Scheme were much smaller than the gilt purchases undertaken through the APF. Initially, critics of the Scheme pointed to the small amount of bonds purchased as a sign of failure. However, the Bank insisted that this reflected a misunderstanding of the Scheme’s intent, which was to improve the process of price discovery and encourage private sector demand (Fisher 2010). In addition, Bank officials noted that though large scale corporate bond purchases may have helped drive down market spreads, it also may have displaced private sector demand, asserting that “the problem was in the functioning of the market, not a lack of demand for the assets” (Fisher 2010).

In each auction, the Bank was restricted to buying no more than £5 million of each bond, depending on the amount of the issuer’s outstanding debt. Though that amount was relatively small, the frequency of the auctions, which at the beginning of the Scheme occurred four times a week, was intended to signal to bond holders that they could sell bonds if necessary. The Bank believed that this would lower the interest rates that counterparties charged for holding corporate bonds (Benford et al. 2009).

Purchasing small quantities of corporate bonds also aligned with the MMLR framework, which the Bank specified involved transacting in “modest quantities” (Fisher 2010). Purchases through the Scheme were much smaller than the gilt purchases undertaken through the APF. Initially, critics of the Scheme pointed to the small amount of bonds purchased as a sign of failure. However, the Bank insisted that this reflected a misunderstanding of the Scheme’s intent, which was to improve the process of price discovery and encourage private sector demand (Fisher 2010). In addition, Bank officials noted that though large scale corporate bond purchases may have helped drive down market spreads, it also may have displaced private sector demand, asserting that “the problem was in the functioning of the market, not a lack of demand for the assets” (Fisher 2010).

The Scheme was a part of an Asset Purchase Facility (APF) that had a ceiling initially set at £50 billion. However, for the Scheme, rather than setting a specific timeline or target purchase amount, the Bank of England designed the facility to last for as long as the highly abnormal conditions in corporate credit markets that were impairing finance of real economic activity persisted (Bank of England, “Market Notice: Asset Purchase Facility,” 2009).

Before the operation of the Scheme, a market notice announcing the program requested feedback from the industry. The request included invitation for detailed comments from all interested parties—existing and potential new issuers, investors, intermediaries, and infrastructure providers, including issuing and paying agents and ratings agencies (Bank of England, “Market Notice: Asset Purchase Facility,” 2009).

Unlike the CPF, the Corporate Bond Secondary Market Scheme specifically targeted secondary market liquidity. The goal of the Scheme was to improve impaired market liquidity that had resulted from dealers’ capital constraints and risk aversion during the crisis (“Markets and Operations,” 2009). Secondary market illiquidity in turn restricted the strength of the primary market, impairing access to credit. To improve secondary market liquidity, the Bank purchased corporate bonds exclusively from market makers (Bank of England, “Market Notice: Asset Purchase Facility,” March 19, 2009).

These design decisions reflected the Bank’s desire to act as a Market Maker of Last Resort (MMLR). As an MMLR, the Bank hoped to “aid improvements in the liquidity of the market, including by reducing the inventory risk to ‘market makers’” (Tucker 2009). Though the Bank purchased bonds only in the secondary market, it believed that establishing itself as an MMLR would reinvigorate both the secondary market and the primary market (Fisher 2010).

Unlike the CPF, the Corporate Bond Secondary Market Scheme specifically targeted secondary market liquidity. The goal of the Scheme was to improve impaired market liquidity that had resulted from dealers’ capital constraints and risk aversion during the crisis (“Markets and Operations,” 2009). Secondary market illiquidity in turn restricted the strength of the primary market, impairing access to credit. To improve secondary market liquidity, the Bank purchased corporate bonds exclusively from market makers (Bank of England, “Market Notice: Asset Purchase Facility,” March 19, 2009).

These design decisions reflected the Bank’s desire to act as a Market Maker of Last Resort (MMLR). As an MMLR, the Bank hoped to “aid improvements in the liquidity of the market, including by reducing the inventory risk to ‘market makers’” (Tucker 2009). Though the Bank purchased bonds only in the secondary market, it believed that establishing itself as an MMLR would reinvigorate both the secondary market and the primary market (Fisher 2010).

As previously discussed, the Bank made pricing information publicly available after each reverse auction. This was critical to improving price discovery and transparency and to establishing pricing points (“Markets and Operations,” 2009). This transparency aimed to reduce uncertainty over the market value of corporate bonds, in turn reducing the risk aversion that contributed to market illiquidity (Benford et al. 2009). 

Despite improvements in the primary market throughout 2009, dealers in the secondary market were still reluctant to trade in corporate bonds. Illiquidity in the market was attributed to an absence of buyers as well as to dealers’ fears that they would be unable to buy back bonds from the APF (“Markets and Operations,” 2009). This led to the Bank’s decision in early 2010 to open up the Scheme to sales as well as purchases of corporate bonds (Fisher 2010). Bank documents confirm that the extension of the Scheme to sales was specifically aimed toward “catalys[ing] secondary market liquidity” (Bank of England, “Market Notice: Asset Purchase Facility, Corporate Bond Secondary Scheme,” December 22, 2009).