U.S. investors turn to more dealers as bond liquidity declines

NEW YORK, Sept 18 Wed Sep 18, 2013 12:01am EDT

NEW YORK, Sept 18 (Reuters) - U.S. fixed-income investors are turning to a greater number of dealers to find liquidity as higher bank capital rules lead dealers to reduce their market-making activities, according to a study by Greenwich Associates released on Wednesday.

Dealers are focusing more of their activities on their largest clients as they shrink their balance sheets and as trading margins for fixed-income instruments come under pressure, Greenwich said. Smaller funds, as a result, are struggling more to complete affordable trades.

Fixed-income buyside firms are expanding the number of dealers they trade with, to an average 9.4 this year, up from 9 last year and from 7.6 in 2009. The survey is based on responses from an average 1,122 U.S. fixed-income investors.

"Stricter bank capital requirements have drained liquidity from the U.S. fixed-income market," Greenwich said in the report, saying that 85 percent of its respondents cited reduced market liquidity as among the most important issues faced this year.

Some investors also complained that turnover at banks has reduced their ability to execute timely and affordable trades as they deal with less experienced staff.

At the same time, more buyside firms say that they have increased trading with firms that provide them research, as banks become more selective in sending out reports. The number of firms that say they reward dealers for research increased to 45 percent, up from 28 percent last year.

Many firms that use derivatives, meanwhile, waited until the last minute to prepare for new rules that require them to send trades to central clearinghouses, resulting in them having to accept unfavorable terms from brokers to gain access to clearing, Greenwich said.

The shift to clearing has not yet created a noticeable impact on swaps market liquidity, though some short-term disruptions were still seen as likely.

Greenwich said the introduction of electronic trading in derivatives is likely over time to benefit smaller- and mid-sized investors with tighter spreads and access to more liquidity providers.