How are corporate bonds hedged with US Treasuries and what are the current risks?
For US corporate bond investors and dealers, hedging to offset interest rate exposure with US Treasuries adds a whole new layer of complexity in executing a corporate bond transaction. These markets are intrinsically linked with the majority of corporate bond trades requiring a corresponding US Treasury hedge trade. Roughly 90% of US High Grade credit trades on Tradeweb are executed with a corresponding Treasury hedge.
Costs associated with spotting and hedging are the result of Treasury bid/ask spreads and inefficiencies that have long been embedded in workflows. When the trade is spotted, there is often a delay as the trader on the dealer desk calls the Treasury desk to get a price before execution, and up to a fifteen-minute time lag is common. Not only does this take time out of a trader’s day, but it affects the all-in price of the corporate bond, which eats into returns.
What challenges are traders facing when looking to safely and efficiently hedge their corporate bond trades?
At a time when swathes of credit trades are going electronic, the stuttering manual spotting process is increasingly outdated. It’s operationally clunky, as firms are trading multiple bonds and spotting for different benchmarks throughout the day, and every trade requires its own set of workflows. This can impact execution quality and trading costs.
When facing the challenges around spotting, buy-side firms can consider mitigating measures, such as trying to achieve the same exposures through fewer individual bonds. But this would be the tail wagging the dog. Clients clearly prefer to expand their options for tailoring corporate bonds exposures, not minimise them.
Technology, however, provides an alternative approach.
How is technology addressing the inefficiencies and risks here?
The Tradeweb Net Spotting solution has been a multi-stage evolution through partnership with our clients. We first addressed the challenges around spotting with an automated process of aggregation and netting of Treasury spots applied across a firm’s corporate bond transactions and relationships.
More recently, Tradeweb introduced Multi-Dealer Net Spotting. This allows clients to take baskets of Investment Grade trades, both voice and electronic, across a wide range of providers and execute the risk electronically and then price and STP all of those trades at once. Before the introduction of this patent-pending system, the positions would most likely have been aggregated over a period of time against multiple dealers with different legs being spotted at different times with different Treasury prices. With Tradeweb Net Spotting, all the spots occur at a single moment across multiple dealers.
How can firms benefit from Net Spotting?
It’s the equivalent of compressing multiple conversations into just a few clicks, delivering scalable savings in execution costs for all participants that have never before been captured. By fully integrating Tradeweb’s robust US Treasury composite of 20+ contributing dealers into the net spotting tool, buy-side traders no longer need to wait for a Treasury quote. This reduces the chance of slippage and frees up time to focus on value-add and portfolio construction. Plus, instead of pricing these bonds separately and receiving two Treasury spot prices – one at the bid side and one at the offer side – both trades would be spotted at one price instead of having to pay the bid/ask on the Treasury bond.
Net Spotting has already proved popular among Tradeweb clients. More than $147 billion has been spotted already this year and firm participation is up 70% since 2018. Not only is Net Spotting saving clients real money, which directly improves their investors’ returns, but the streamlined workflow enables simpler production of pro forma audit trails and reduced chance of transaction failure. Furthermore, firms can optimise the frequency of their spot- hedging activities over time based on the number and characteristics of their trades and their portfolio requirements.
How can traders leverage Net Spotting in conjunction with execution protocols?
Net Spotting works across all of Tradeweb’s execution protocols including: electronic RFQ, All-to-All, voice processed trades, automated trading, click-to-trade and portfolio trading. This gives traders complete flexibility in their trading strategy while still offering them the post trade efficiencies and cost savings of Net Spotting.
Traders looking to execute large lists or portfolio trades, which can number hundreds of individual line items, are particularly good candidates for Net Spotting. With a traditional hedging workflow, traders had to price these spread-based bonds separately and receive two Treasury spot prices. Tradeweb Net Spotting saves them from paying the bid/ask on the Treasury bond for hundreds of line items, which quickly adds up to a lot of savings.
How do you see innovation helping the credit markets evolve?
As the credit markets become further digitised, there’s more opportunity for convergence across markets and client sectors. Tradeweb is the first electronic platform to fully integrate the corporate bond and US Treasury markets in one place for seamless spotting and hedging. But it won’t stop there… our live streaming liquidity was made possible through an integration with Tradeweb Direct, giving Institutional credit traders access to middle market and non-traditional liquidity providers and vice versa.
With over 40 products on our platform, Tradeweb is in a unique position to connect traditionally siloed markets, uncover new ways to innovate and provide efficiency through technology to clients.