Bonds struggle in transition to e-trading
Aug 9 (IFR) - Banks and investors are losing hope that the US corporate bond market will ever have the thriving electronic trading system seen in stocks, despite years of efforts on both sides to build interest in doing business electronically.
According to experts, the e-trading systems developed in the last few years have not managed to expand overall liquidity in the market - which is the main aim in creating such a network.
"If you look at the last few years, the corporate bond market has grown from US$6trn to US$9trn, said Rick McVey, CEO of MarketAxess, which is the biggest electronic trading platform, with about 14% share of all daily trading volume in US investment grade corporate bonds.
"But TRACE volume has remained flat," he said, referring to the system in which broker-dealers are obliged under SEC rules to post OTC secondary market trades in fixed-income securities.
"That means the annual turnover of outstanding debt has been falling," McVey said. "This is what we, investors and dealers are all trying to solve."
A report by McKinsey & Company and Greenwich Associates this week concluded the bond market just isn't made for equity-like trading - and that bond trading might never develop much beyond its current form.
"True electronic match-based trading, like that seen in cash equities, remains a distant dream," said the report from the two consultancies, which surveyed 117 market participants.
It said the corporate bond market was "unsuited" to e-trading and could remain driven by sellside dealers, "in stark contrast to the largely order-driven cash equities market."
Before the onset of the financial crisis, big firms like BlackRock, Fidelity and bond giant Pimco were able to easily buy and sell large blocks of bonds of US$25m or more in size.
But stricter regulations on risk, put in place after the crisis, have made it prohibitively expensive for banks to buy large chunks of their clients' bonds and then leave them on their balance sheets until they can sell them.
Instead, investors are now forced to break up big block trades into bite-sized pieces of just a few million so that the Street can digest them.
That liquidity gap, in theory at least, created an opening for electronic platforms that would allow more frequent - and smaller - bond trades between investors.
So-called Request For Quote (RFQ) platforms like MarketAxess, for example, help investors seek bond prices from dealers online instead of having to phone them as has been the custom for decades.
But many investors will only use RFQ platforms for certain deals, saying they are wary of being exposed online. And because such platforms are still largely beholden to dealers, they have not been able to expand liquidity overall.
"They are great for very liquid on-the-run bonds that are widely owned," said Frank Reda, director of trading at Taplin, Canida and Habacht.
"But you will get killed if you put up [for sale] certain illiquid bonds that you might be known as a buyer of in the past."
And Dexter Senft, co-head of fixed-income electronic trading at Morgan Stanley, said one of his most important discoveries in the past year was that bond investors largely didn't want to trade directly with one another.
"They want to put out a request to buy or sell bonds, but they don't feel comfortable being on the other side of that request, like a dealer would," he told IFR.
"It comes as an unnatural act."
Morgan Stanley is just one of many firms - including Goldman Sachs, BlackRock and UBS - that tried to fill the gap by launching its own "single-dealer" bond-trading platforms.
The idea was that investors could trade bonds with each other anonymously. But few people involved in the development of these expensive platforms - if any - understood how little market appetite there is for that kind of investor-to-investor trading.
For one thing, investors weren't keen on platforms run by just one bank, or by one of their competitors.
"It was not obvious a year ago that single-dealer platforms would not work," said MarketAxess's McVey.
The report from McKinsey and Greenwich spelled out exactly who liked the single-dealer platforms: "Almost no one".
TIME TO AGGREGATE?
Now some big investor groups are kicking the tires of technology like InterDealer's CreditStation, which aims to pool the available liquidity of each participating e-trading platform onto one screen.
Known as a "super-aggregator", this kind of hub would allow everyone in the market - including dealers and investors signed up to another e-trading platform - to meet in a central location without the worry that the platform is under the control of an individual firm.
Some in the market feel that this would be the most effective way to make electronic bond trading a viable possibility.
"If the main client base says 'I want to go to this place of aggregation, this is where we are piping into and you have to get on the bandwagon', then the Street's going to do it," said one senior executive at an asset management firm.
"Existing platforms don't lose by piping in because they will still get paid for the trades they generate."
MarketAxess is keen to turn itself into the central hub of activity by getting other single dealer platforms to follow BlackRock's footsteps and hook up to it.
But it is not clear if competing platforms are ready to work together - and that willingness is key to making such centralized systems work.
In any event, it seems clear that thriving real-time "click-and-trade" between investors - or even with their dealers - is still some ways off.
"You need an all-to-all electronic trading platform that aggregates liquidity and involves dealers as well as a broad range of investor types," said Richie Prager, global head of trading at BlackRock.
Prager admitted it had been difficult to go it alone with BlackRock's invitation-only investor-to-investor trading system - a system that is now partnered with MarketAxess - and that broader changes in the market would take time.
"This will be more of an evolution than a revolution," Prager said. "It could take 10 years. Look at how long it took equities to become electronic."
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