Third-party trading platforms that enable investors to deal in fixed income with each other are becoming a bigger feature of the market, but can they really match the liquidity the banks were once able to offer?
How are multi-broker trading platforms altering the way fixed income products are traded?
Much as seen in the equity markets, fixed income trading has become even more fragmented, though the reasons for this differ. Fixed income has always suffered from many firms having multiple bond issues active at any one time, but the addition of multiple trading venues and principal dealers adds to this complexity. While regulatory change in the equity market was specifically intended break up the monopolies of the incumbent national exchanges and create choice, fixed income itself has not seen such direct regulatory intervention. That said, regulations such as Basel III are making it more costly for banks to hold large amounts of inventory, which means they can no longer provide liquidity across the fixed income markets, leading to clients including asset managers to look elsewhere.
Enter the platforms. Firms such as MarketAxess, which started out offering request-for-quote-based intermediation between brokers and their clients, are now seeking to provide an exchange-like model for investors to trade bonds with one another. The principle is simple enough, if the bank cannot provide liquidity to the buy-side, why not provide the tools for the buy-side to access each other directly? This all-to-all model is very similar to the way an equity exchange works and its supporters say it is the future of fixed income trading.
What are the barriers to all-to-all trading of bonds on platforms?
While the all-to-all model is receiving a lot of attention right now, there are many potential pitfalls to establishing this protocol as the standard for fixed income trading. Firstly, the nature of fixed income markets means there is a vast range of instruments to be traded, though each offers little liquidity. For example, if you want to buy or sell equity in Vodafone, you are trading the same share regardless and there will likely be thousands of orders for this share each day.
But if you want to trade Vodafone bonds, you have many different bonds to choose from, each with different maturities and rates. While I might want to sell or buy a particular bond, there may be none available on the market at the time. This has been the reason secondary bond markets have been relatively weak, while banks have dominated due to their ability to take on the risk of fixed income trading on behalf of their clients.
Critics of the all-to-all model have said it is simply impossible for the buy-side to trade with each other in any meaningful scale due to this additional layer of fragmentation affecting the market at the product level. Even its supporters have called for corporates to issue bonds based on a limited number of benchmarks to make them more palatable for institutional investors.
What potential concerns are there when connecting to these platforms?
Connectivity cost and maintenance has become a major cost burden for the buy-side and their sell-side counterparties. Adding in a range of new trading platforms will inevitably add to this. While in equities most investors can continue to rely on their brokers to connect to the multitude of different venues on their behalf, fixed income platforms may not benefit from this same level of support.
Many brokers see independent platforms as directly competing with them for buy-side business and as such are not supportive of all-to-all platforms, which would effectively cut them out of the money in many trades. The result is institutional investors may have to stump up the cash to connect themselves, which could become very expensive as the market expands.