* Interest rate cycle could turn sentiment
* Secondary market suffers from an inadequate model
* New trading platform initiatives will be tested
By Laura Benitez and Alex Chambers
LONDON, Aug 22 (IFR) - A return to interest rate normality
and a central clearing engine could address the liquidity risks
faced by corporate bond investors, after this month's market
volatility highlighted how passive dealers have become.
But does it even matter that a European corporate bond now
trades on average once a day, according to RBS, compared with
nearly five times a day just over a decade ago?
Yes, say those who point to increased European investment
grade bond issuance. That supply year-to-date stands at
168.6bn, compared to 98bn in the same period in 2007,
according to Thomson Reuters data.
"I think the market is temporarily stabilising, and should
probably be OK for the next month. But Fed tapering will be
completed in October, and there will be renewed focus on the
first interest rate increase in the US, so I do expect another
bout of money exiting credit, and another illiquidity period,"
Derrick Herndon, head of long corporate credit business and
portfolio manager at PVE Capital.
Obviously the interest rate cycle is at a different stage on
either side of the Atlantic but where the US credit market
leads, Europe tends to follow.
Investors complain vociferously that dealers are now no
longer willing to stand as principals behind a trade. Instead of
making markets and taking risk positions to facilitate liquidity
for end clients, they are now merely acting as agency brokers.
Inadequate secondary market liquidity is one of the reasons
behind the launch of buy-side focused e-trading solutions like
BlackRock's Aladdin and GSessions from Goldman Sachs, but none
have proven a real success.
None of these addresses the fragmentation in the credit
market. There is Bloomberg's ALLQ, Tradeweb, part-owned by
Thomson Reuters, and BondVision, while MarketAxess has taken
Some in the industry are trying to consolidate liquidity,
which is the concept behind Oasis, conceived by Deutsche Bank,
an e-trading solution to pull all types of venues and investors
"Over the last year there have been various initiatives all
based on different protocols. During 2014 a common theme has
developed which is a convergence towards a form of matching
engine protocol which honours the unique characteristics of the
credit market," said Dominic Holland, global head of e-credit
sales at Deutsche Bank.
A matching engine, which puts together motivated buyers and
sellers could be a lot more efficient than dealers shopping
around until they find an axe.
TOO MUCH TRANSPARENCY
"One of the challenges for investors is that when they are
contemplating a trade, leakage of that information can
potentially adversely affect the price of that security, and
indeed the entire curve of that borrower," Holland said.
The idea of a matching engine is similar to the concept
behind a new platform, Bondcube, which is yet to launch. There,
players will post actionable indications of interest in a
security. There is no hard obligation to act, but the system
will discretely look at what other interest is out there and try
to match buyers with sellers. It also stores those indications
for future reference.
Holland said Oasis should facilitate the trading of bonds
that currently trade infrequently, or not at all. If this is the
case, it could unearth significant volumes; according to the
SEC, nearly 20% of all corporate bonds do not trade at all.
The problem facing Deutsche Bank, which has pushed this idea
for a year, is that the industry has failed to back it. The big
hurdle for any start up is the lack of critical mass. And to get
funding for speculative I.T. build out is not easy in the
Furthermore, there are varied interests at work, so to get
the project off the ground, an independent player like an
exchange could prove key. There is already evidence that they
are taking notice, earlier this year Deutsche Bourse announced
its backing for Bondcube.
The exchanges are already used to the idea of semi-lit and
dark pools of liquidity in equities. But unlike equity markets,
fixed income trading prospers on reduced transparency.
And over the last month there's been more noise that an
exchange could step into the void within Oasis, with some action
expected in the early part of next year.
Before then, the market may well face a test of liquidity in
the Autumn, a period when volatility is commonplace as bigger
investment strategies are put in place after players return from
their summer breaks.
One banker says we could see some "big bets being put on".
Despite potential changes and dangers ahead, market players
are dismissing the recent media frenzy over a potential mass
sell-off in the corporate market. Many say there is relatively
little to suggest that everyone is on the point of rushing for
the exits just now.
"It's a bit like being in a crowded theatre in which the Fed
has suddenly shouted, 'Fire! Please leave in an orderly
fashion.' Your best guess is that the exit will be orderly -
especially when they're only whispering, and we had a fire
practice last year," Matt King, global head of credit products
strategy at Citigroup said.
"There's a constant risk of it becoming disorderly, and that
doesn't just depend on how loud the Fed shouts, but on a complex
interaction between the individuals in the theatre."
(Reporting by Laura Benitez, Alex Chambers; editing by Julian