Buy-side firms are hoping new electronic platforms will do for bond trading what the internet did for dating, reports Dan Barnes.
Hooking up bond traders looking for deals used to be easy, but asset managers have been desperately searching for new sources of liquidity since banks were pushed out of the business. The corporate debt market has been punished by the limits that regulations have imposed on banks’ trading activity. Basel III is racheting up the capital requirements for banks to hold inventories of bonds, while the Volcker Rule, part of the Dodd-Frank Act in the US, is preventing banks from trading off their own book.
The nature of the bond market makes it more susceptible to liquidity droughts than other asset classes. Companies issue bonds to meet particular cash flow needs, creating a much broader range of instruments for each firm than is found in the equity markets and each instrument is much less actively traded as a result.
Jim Rucker, credit and risk officer at bond-trading platform MarketAxess, says, “In the US high grade market there are something like 45,000 different instruments, which goes up to 75,000 if you include high yield bonds. According to our analysis, when you look at the market as a whole, there are only approximately 20 bonds that trade each day on both sides of the market in institutional size. So, very few bonds have anything close to a two-way market during the day. That means dealer capital has been very important to the market.”
Having peaked at around $235bn in 2007, sell-side inventory levels are now around $40bn. For the bond trading market losing this capital commitment is a concern. “More than 70% of the total corporate bond inventory is now owned by insurance funds, pension funds or large asset management organisations,” said Jean-Philippe Male, CEO of Galaxy MTF.
Wedded to the widening of spreads – which Larry Fink, CEO of BlackRock, observed was a probable effect of the new regulation – it is a disaster. “The market is very unhealthy; prices from banks and counterparties are very poor,” said one asset manager, who asked not to be named. “Bloomberg All Quote has prices on it but when you try to trade they disappear. I never saw such bad liquidity in the market as it is today. Three or four years ago after Lehman there was a brief patch but now it’s a prolonged period of illiquid markets. We are saying here that we’re glad we don’t have any big orders because the market just couldn’t absorb them.”
Into the breach
Into this arid market new trading venues are launching. Creating more places to trade might seem counter-intuitive when liquidity is already hard to pin down, however in markets without centralised venues it could be just what the doctor ordered. With a decline in sell-side liquidity, the obvious solution is to look for ways to connect up buyside counterparties. “Clearly many people are looking at whether alternative trading styles can help solve some of the liquidity problems in the credit market,” says Rucker.
This year asset manager BlackRock is planning to launch the Aladdin Trading Network (ATN), a fee-based crossing service for its buy-side clients, which it hopes will be a “paradigm shift in the way corporate bonds are traded on the buyside.” It is planned that the platform will be opened for the trading of equities and other securitised assets at a later date.
Larry Fink has said he hopes his firm, which currently crosses about 6% of its trades, could cross as much as 30% of trades although he has been cautious about the speed at which that would happen. “If we could see a narrowing in bid-ask spreads, quite frankly we don’t need the Aladdin trading platform,” he said during the Q1 analyst call. “If we are seeing a persistent widening in spreads, we believe this system will flourish and grow.”
“Buyside firms don’t like working directly with only one dealer or dealer platform,” says Francesco Cicero, head of e-Trading at interdealer broker GFI. “They have no issues with opening up the market although that is not ideal for dealers. As a result, dealers are looking for intelligent ways to retain the order flow with the buyside firms without necessarily on-boarding the risk. A way to do that is to pass it to someone else as quickly as possible, matching client orders where actually the dealer just intermediates the trade.”
Broker Goldman Sachs launched a bond trading platform in June called GSessions. It offers two five-minute trading sessions on Tuesdays and Thursdays, one dealing with a high yield bond and the other an investment grade bond, and both supported by a fixed level of liquidity guaranteed by the bank.
The firm has rolled out the service in US and Europe and plans to increase the frequency if the platform is successful.
Investment bank UBS’s single-dealer platform, Price Improvement Network – Fixed Income (PIN-FI), also allows trading of fixed income although the volumes seen are low at present. Michael Cannon, co-head of investment grade trading at UBS said “PIN as it currently exists typically clears some of the smaller transactions, meaning it is used for matching customer inquiries and improving price and liquidity on the smaller transactions for clients as they adjust and rebalance their portfolio.”
He notes that the service is meant to facilitate liquidity for the customer base, acting as “an additional outlet rather than being an alternative way of going to the dealer community, as with some electronic markets.”
In January 2012 PIN became a liquidity supplier to Galaxy, a fixed income multilateral trading facility (MTF) launched by trading system supplier TradingScreen in 2011. The firm which operates a central limit order book, had itself been set up in response to a call from the French government’s economic ministry, which was concerned about the limited liquidity and transparency in Europe’s bond market.
“With TradingScreen we have created a price aggregator that goes across banks, MTFs and regulated markets to provide a full picture of the market. Clients should be able to access all of these pools and trade on any model they wish,” notes Male.
Established platforms such as MarketAxess are also looking to introduce different trading styles.
“Traditionally, on MarketAxess, we have provided the ability for institutional investors to send request-for-quotes (RFQs) to a group of market-making dealers,” says Rucker. “Recently we’ve introduced a functionality called Market Lists that allows an investor firm to send the RFQ to the dealers of their choice, but at the same time to send it out to buy-side users on the platform. If an investor finds an order for a bond on the list, from another investor, which matches their requirements they can trade against it. So with Market Lists we are bringing buy-side institutions together to trade bonds, although there is always a dealer used as intermediary.”
There is some scepticism on the buy-side as to how successful these new entrants will be.
“When a venue carries the name of a bank I am suspicious, I think venues should be more objective,” said the chief executive of mid-tier asset manager. “I see more potential for Galaxy and NYSE Euronext’s BondMatch because you have to be so careful a bank is not putting its trader in front of an order.”
Stuart Campbell, head of global fixed income trading at asset manager Invesco, uses electronic RFQ platforms aggressively but currently avoids crossing platforms or single dealer platforms.
“Smaller trades will always be run across electronic platforms because it is efficient to request multiple quotes in a size up to about $10m, for liquid on-the-run deals,” he says. “I don’t think bringing in new execution venues will have a dramatic impact on liquidity. It will probably help, but most of these systems really need meaningful traction which can take years. If you look at the RFQ systems like Tradeweb, MarketAxess and Bloomberg they were slow to get started even where they had bank sponsorship.”
He suggests Aladdin would have potential, but BlackRock might need to tackle the issue of streaming prices from the banks into the system.
“If you don’t have a live price how do you know where to set your bid or your offer as a client?” he asks. “Or if you could combine BlackRock’s platforms with a session model with five-minute windows, you wouldn’t have the need to stream live prices all the time.”