The market for fixed-income ETFs is expanding among institutional investors, for whom they are effective liquidity tools for portfolio balancing, sector allocation shifts and portfolio transitions. In addition, fixed income tactical beta exposure may be achieved more rapidly through the ETF structure.

The problem is that capital constraints imposed on banks by Basel III has caused many of them to exit the market-making business, which means that sourcing liquidity for bond ETFs has become more difficult. In this environment, the traditional client-to-dealer RFQ model is giving way to open trading.

“It is a bit more of a complex structure with bond ETFs, because they don’t have the same kind of liquidity and availability as equity ETFs, Richard Schiffman, Open Trading product manager at MarketAxess, told Markets Media. “Fixed income ETFs have this unique characteristic where the holdings of the funds are different than the bonds that you can create shares in the funds, which are then different than the bonds you would get in return during redemption.”

To resolve this conundrum, MarketAxess has expanded its Open Trading protocol to enable ETF market makers to more quickly identify counterparties from whom they can source the underlying components of BlackRock iShares.

The consolidated iShares content on the MarketAxess trading system enables ETF market makers to trade baskets of iShares ETF constituent bonds using MarketAxess’ list trading functionality.

“It is the first of what we think will be quite a bit more functionality in the area of ETF development, in particular fixed income ETFs, and we think it is a natural fit for users of our system,” Schiffman said.

Patrick Dunne, head of iShares Global Markets & Investments at BlackRock, said in a statement: “We’re pleased to announce this partnership with MarketAxess so that authorized participants and ETF market makers can efficiently trade baskets of iShares ETF constituent bonds. This will ultimately help institutional investors add fixed income ETFs to their investment portfolios.”

The company’s Open Trading environment for corporate bonds offers a range of protocols, or trading workflows, in addition to MarketAxess’ request-for-quote model, such as Market Lists, an order book providing all-to-all execution based on disclosed and anonymous trading across trade sizes (odd, round and block).

The Open Trading protocol enables market makers to source pricing from multiple counterparties and to view ETF bond constituent activity for insight into actively traded bonds.

“Open Trading, and in particular Market Lists, is an expansion upon the classic RFQ model because now instead of only going to the firms that you have relationships with, meaning your coverage on the Street, you now can go out publicly to every participant on the system and trade through MarketAxess or another dealer representing their response,” Schiffman said.

List trading for constituent bonds with flexibility to trade all or part of the basket, improving efficiency for the create/redeem process.

ETF market makers have been a growing group of participants on the MarketAxess platform, and have desired the ability to trade the underlying baskets for creating and redeeming shares.

“For the market makers, it is definitely a boon with regard to the transparency about the funds and having the information available in the trading system to make their workflow more efficient,” Schiffman said. “It makes it very easy for them to now see what bonds are eligible for creating or redeeming shares in the funds and at the press of a single button, they can generate a list from anywhere from some of the baskets are as small as twenty to as many as a couple of hundred line items.”

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