Bond Trading Platforms Proliferate

Terry Flanagan

With upcoming regulation set to cull some of the fixed income operations at the big banks, new bond trading platforms are set to pick up the slack.

Having operated in Europe for two years, Vega-Chi plans to launch an independent trading platform for high-yield junk bonds in the U.S. later this year, in a move to capitalize on the growing interest among institutions keen to trade with each other directly and cutting out banks as middlemen.

“Everything that has happened over the last several years has shown a need for a buy side to buy side market structure component,” said Constantinos Antoniades, chief executive officer of Vega-Chi and a former Goldman Sachs bond trader. “There is a very high market demand for this kind of product. Until a few years ago, clients could rely on the existing structure to get things done, but now banks are not committing as much capital given that they face higher capital requirements, higher funding costs and a number of regulatory hurdles.

Because of the nature of the fixed income business, banks acting as intermediary between trades can significantly weigh down balance sheets.

The average bond trade is usually in the millions of dollars in value, while the average equity trade consists of only a few hundred shares. In addition, because the market is less liquid, an intermediary, such as a broker-dealer, may need to hold on to the assets longer in order to find the other side of the trade. This is a problem when it comes to the large banks needing to trim down their balance sheets to comply with Dodd-Frank regulations.

“Banks simply cannot cover this market the way they used to,” added Antoniades. “They have fewer people than in the past and smaller capital commitments.”

In addition, Vega-Chi will look to attract order flow through lower fees, as being an independent firm means it has fewer overhead costs.

“Fixed income investors have been paying too much the last few years for traditional dealers and brokers,” said Antoniades. “Clients have told us how much need there is for direct access to liquidity and at a lower cost. They have told us that they need to be able to access flows from other clients directly without having to rely on two salespeople to do the job.  This makes a lot of sense given that institutional investors represent the real liquidity and depth in the high yield bond market as they hold 95-98% of the asset class.”

Vega-Chi was founded in 2008 and launched its first platform for convertible bonds in Europe in 2010. Early this year, it launched a European platform for high yield and subordinated financial bonds. Its clients can trade on its venues completely anonymously. By bypassing the traditional fixed income intermediaries, Vega-Chi can offer lower fees and greater transparency. Between the two venues, the firm has about 100 users. The U.S.-based platform will have around 50-70 users at launch, which is expected to be in September.

While Goldman Sachs may be one of the big banks which historically have derived a large portion of their revenue from bond trading and sales, it will need to cut back on that side of its business if Dodd-Frank regulation goes through as currently constituted. The bank is reportedly readying GSessions, an automated electronic trading platform for corporate credit, for launch in the near future after technical glitches scuttled a planned mid-May unveiling.

Operating a trading platform where natural buyers and sellers can be matched up would stand to eliminate any regulatory concerns, while at the same time allow its operator, Goldman Sachs, to continue to attract fixed income trading flow.

According to reports, GSessions was to launch by the end of May, but was pushed back due to technical issues. It is likely erring on the side of caution, especially in the wake of high-profile technical mishaps such as the Facebook initial public offering on Nasdaq OMX.

Fitch Ratings research found that a potential industry shift toward electronic bond trading platforms could, over time, compress fixed-income margins. However, any margin compression would likely be less acute for major trading banks than what had been experienced in equity trading as it migrated to electronic platforms in previous years.

Fitch found that fixed-income instruments are generally less susceptible to commoditization, given variances in size, structure, and maturity. The continued development of electronic bond trading could potentially alter the playing field over the medium term, spawning increased competition in the space. In response to potential competition from independent third-party vendors, certain financial institutions are in the process of introducing their own competing platforms.

BlackRock recently announced the Aladdin Trading Network, which is intended to cross client bond trades. BlackRock would receive a fee, smaller than the fees charged by banks, which would cover associated costs. It has many market participants wondering if it will become more common for the buy-side to look to bypass the traditional Wall Street firms with their own trading platforms.

Market observers have noted that creating trading platforms for only certain types of market participants, such as institutional traders, can only be beneficial to the markets if there is sufficient liquidity. It remains to be seen if buy side to buy side trading platforms can be sustained for the long term.

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