MSRB Chief Economist Simon Wu published an analysis of the relationship between exchange-traded funds ("ETFs") and liquidity in the municipal bond market. Despite recent research indicating an inverse relationship between ETF growth and underlying bond liquidity, the report did not find any evidence that ETF growth has an impact on municipal bond market liquidity.
In the report, Mr. Wu explained that municipal bond ETFs have undergone substantial growth over the last 10 years, and suggested that the growth is likely to continue for the near term. He noted that issues in ETF markets include: (i) liquidity mismatches between ETFs and underlying bonds, (ii) price deviations related to market structure issues, and (iii) volatility from the creation and redemption process.
MSRB staff conducted an empirical analysis to determine whether municipal bond ETF growth from 2007 to 2017 impacted secondary market trading over the same time period. The analysis did not find any evidence to support a correlation between ETF growth and liquidity. However, Mr. Wu acknowledged that ETFs are dependent on the underlying bond market liquidity, and cautioned that it is possible for future ETF market growth and rising interest rates to have an impact on liquidity. He emphasized the importance of improving liquidity in order to promote healthy markets and provide access to capital for both investors and municipal entities.
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