Non-technical summary of ESM Working Paper 58 "Collateral pledgeability and asset manager portfolio choices during redemption waves"

Global corporate bond markets witnessed severe liquidity strains and price pressures during the onset of the Covid-19 pandemic. The sudden drop in bond prices was driven by managers of open-end investment funds trying to finance redemptions by selling the underlying assets, and a reluctance of dealers to expand their inventories to accommodate the surge in demand for liquidity.

This paper studies whether Eurosystem collateral eligibility played a role in the portfolio choices of euro area asset managers during this so-called ‘dash-for-cash’ episode. We find that asset managers of investment funds reduced their allocation to ECB-pledgeable corporate bonds,¹ selling them to finance redemptions, while simultaneously increasing their cash holdings. These findings add nuance to previous studies of liquidity strains and price pressures in the corporate bond market during the onset of the Covid-19 pandemic, indicating a greater willingness of dealers to increase their inventories of corporate bonds pledgeable with the ECB. 

Analysing the price impact of these portfolio choices, we also find evidence pointing to price pressure for both ECB-eligible and ineligible corporate bonds. Bonds that were held to a larger extent by investment funds in our sample experienced higher price pressure, although the impact was lower for ECB-eligible bonds. We also discuss broader implications for the related policy debate about how central banks could best mitigate similar types of liquidity shocks. We argue that our findings add weight to recently made calls for central banks to extend refinancing facilities to non-bank financial institution (NBFI) counterparties, including investment funds.

¹ In this context, a corporate bond is considered to be pledgeable if it is an eligible marketable asset under the Eurosystem collateral framework. Eligible bonds may be pledged as collateral in exchange for loans granted in the ECB’s overnight lending or main refinancing facility.