New US bond market starts to take shape

Access to fragmented bond market liquidity is high on the buy-side’s agenda, as brokers retreat and a new electronic trading landscape for fixed income emerges, according to new research.

Access to fragmented bond market liquidity is high on the buy-side’s agenda, as brokers retreat and a new electronic trading landscape for fixed income emerges, according to new research.

Electronic trading has hit 22% of the fixed income market, of which 65% occurs on request for quote (RFQ) protocols and 28% on institutional alternative trading systems (ATS), the report by consultancy TABB Group showed.

US bonds saw over US$150 billion in cumulative flows in 2012, with issuance in the primary market at an all-time high in 2012.

Although overall turnover has declined in the secondary market, trade sizes are down and odd-lot volumes are up. Multi-dealer trading platforms are on the rise and ATS volume now accounts for 14% of trading on the secondary market for corporate bonds.

Multi-dealer platforms include the likes of MarketAxess and In November, total trading volume for MarketAxess hit US$54.7 billion and the venue’s highest ADV of US$1.7 billion per day, according to the Financial Industry Regulatory Authority’s TRACE consolidated tape.

Henry Chien, a New York-based TABB research analyst who co-authored the report with contributing analyst Deepali Nigan, said the ability for buy-side desks to trade directly with each other had precipitated major shifts in the US bond market.

“Electronic is no longer a voice equivalent on the screen. Innovative protocols and new order flow networks have a place in this new fixed income universe as many asset managers and exchange-traded fund market makers are finding it more efficient to execute their odd-lot sized trades across ATSs,” Chien said.

Quarterly odd lot volume as a percentage of volume has risen to 11.7% in Q1 2012, from 5.9% in Q1 2008, according to the study.

ATS venues have found success letting buy-side firms trade with each other, such as Vega-Chi, which launched its buy-side only platform for US high-yield and distressed fixed income products in October, attracting more than 40 clients from launch.

The venue lets institutional investors trade directly with each other through an electronic trading platform without the need for an intermediary, offering members better prices and greater control over trades.

The increased use of buy-side-only ATSs and electronic fixed income trading solutions has accelerated since the financial crisis and the impending regulation designed to shore up banks’ balance sheets.

Basel III, the latest set of standards to ensure banks are adequately capitalised, will require them to hold risk-weighted capital against the instruments held on their balance sheets. The added capital will make it more expensive for the sell-side to facilitate the buy-side’s bond trading activity. US banks also face further restrictions through the Volcker rule, a ban on proprietary trading that was included in the Dodd-Frank Act.

The TABB report shows dealers have reduced their corporate securities inventory by 40% from 2008. Meanwhile the corporate bond market has grown by nearly 40% in notional outstanding during the same period, as asset managers seek assets that offer more stable returns.

“The old business model of dealers holding bond inventory is dead. New platforms and products in today’s credit bubble are driving new liquidity dynamics,” said Chien, adding that quantitative easing has also reduced trading revenues.

Exchange-traded funds offering credit market exposures are also growing, according to the report. Average daily notional turnover is up 57% at US$860 million in notional average daily volume (ADV) and underlying bond turnover is up 72%, now US$230 million in notional ADV.

Reshaping Europe

In Europe, the fixed income market is beset by the region’s faltering economic uncertainty, with the euro crisis and a wealth of new regulation.

A report titled ‘Technology in European fixed income: Time to open Pandora’s box’, focuses on technology vendors’ solutions and was released by consultancy Celent this week. It predicts that selecting the right technology to adapt to the new fixed income landscape will be the most important consideration for the buy- and sell-side moving forward.

Author of the report, senior analyst of Celent’s Securities and Investments Group, Joséphine de Chazournes, said regulation would have a major effect on banks, dealers, brokers and investors, as they adapt to the changing environment with a range of new electronic trading solutions.

“We don’t believe there is a magic lamp that will solve the issues the buy- and sell-side are facing, however it is now time to open Pandora’s box for many market players who will have to find a way to make various solutions fit together,” de Chazournes said.