Bond Markets Preclude One-Size-Fits-All Approach

Terry Flanagan

A period of diminished fixed-income liquidity is driving adoption of electronic trading.

“There is a healthy interest in adopting new types of protocols and innovations in the marketplace that would be specific to the credit market, and not just lifted from equities, foreign exchange or some other market which is more advanced in electronification,” said Dominic Holland, director of credit e-commerce sales at Deutsche Bank.

Holland, who traded corporate bonds in London and New York for 15 years, advises Deutsche Bank clients about market structure changes and investment strategies. “With all the regulation at the moment, [such as] Dodd-Frank, Emir and Mifid II, there a number of aspects that are affecting the way people provide liquidity and the timing of what’s available to people,” he said.

Dominic Holland, Deutsche Bank

Dominic Holland, Deutsche Bank

The credit markets are complex, with different styles of trading, precluding a one-size-fits-all approach. “People talk about liquidity issues in the credit market, but the challenges in the index versus single name versus secondary cash markets are all very different,” said Holland. “Actually, when you look at each of those aspects of the credit market, the investment strategies of buy-side firms are very different as well.”

For index funds that are tracking a small number of issues in a low interest rate environment, mid-market matching and reducing bid/ offer is absolutely paramount, because that can significantly enhance returns, Holland said. Whereas more alpha- driven, active portfolio managers may be looking at large positions of new issues, which 18 months later they want to exit after having locked in a profit.

“Those are two very different ways of looking at the market, and the key aspect for me has always been that the credit market is driven by relationships,” Holland said. “Relationships are what trigger people to put capital to work and to engage with each other. There’s an enormous amount of trust that’s been gained by the largest banks with each other, with historical trading relationships.”

The ability of Tier I or Tier II broker-dealers to realize new fixed income dealing models is a reflection of the costs associated with implementing a transformation of the bank’s sales force and trading desks into a vertically-integrated, cross-asset sales-trading organization, according to GreySpark Partners, a London-based capital markets consulting firm.

Many sell-side institutions are increasing the amount of e-trading technology they use to deal corporate bonds and interest rates swaps (IRS), according to a report by GreySpark.

GreySpark estimates that in 2014, 96% to 99% of the corporate bond liquidity that had been warehoused by banks in 2007 is now owned by buy-side firms. Banks are also struggling with the costs associated with developing new fixed income e-trading and e-commerce business models, which are an essential part of the sell side’s overall adaptation to the new regulatory pressures.

E-trading technology can provide new ways for banks to maximize the efficiency of their dealing activities as part of a broader effort across the industry to move from a principal model of trading to an agency, broking-centric trading model. Banks are increasingly adopting new, innovative business models for fixed income dealing in 2014.

“While more electronic dealing venues will emerge in the future to connect buyers with corporate bond liquidity, the sellside must still reorganize itself around corporate bond liquidity pools that allow investors to find inventory wherever possible,” said Frederic Ponzo, GreySpark managing partner. “Ultimately, a better connected marketplace is one wherein consolidated, aggregated liquidity is paired with data mining technology.”

Featured image via Dollar Photo Club

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