Corporate Bond E-Trading Faces Speed Bumps

Terry Flanagan

Full-fledged e-trading in corporate bond markets will be slow to arrive, if it ever materializes, according to research from McKinsey & Company and Greenwich Associates.

Based on a survey of 117 institutional corporate bond investors in the United States and Europe, supplemented by interviews with asset managers, banks and market operators, the McKinsey and Greenwich Associates research provides insights into the future of e-trading in the corporate bond market.

“Despite the launch of several corporate bond trading platforms since spring 2012, the corporate bond market is unlikely to ever resemble cash equities or even foreign exchange,” said Roger Rudisuli, a McKinsey partner and co-head of the firm’s Americas Corporate and Investment Banking practice. “The skepticism revealed by our research reflects both the structural differences between the corporate bond market and e-trading pioneer markets like cash equities and the profound changes in industry conduct that would be required to make bona fide match-based e-trading come to life.”

A major impetus for many of the new e-trading platforms, launched in the past year or so, was the liquidity shortage in the corporate bond market. Until mid-spring 2013, however, the liquidity squeeze was not as bad as many had feared,
according to the McKinsey/Greenwich Associates research. Approximately 30% of survey respondents said that liquidity had actually improved during the prior 18 months. With the phase-in of post-crisis regulation, the majority do expect liquidity to deteriorate, however.

“Buy-siders foresee an evolution, rather than a revolution, in corporate bond e-trading and expect the market to remain predominantly dealer-driven in the foreseeable future, albeit with multiple e-trading models to meet their needs,” said Andy Awad, managing director at Greenwich Associates’ Securities & Trading Practice. “Our research also revealed that multi-dealer request-for-quote platforms are expected to remain the winning institutional corporate bond e-trading model for the next few years.”

The issuance boom in 2012 and follow-on trading in those issues likely buffered the market against a steeper drop in turnover rates. The recent slowdown in new issuance in the U.S., with June 2013 levels falling almost 30% relative to June 2012, may not augur well for corporate bond liquidity going forward.

Corporate bonds are a much more heterogeneous asset class than equities, with 37,000 publicly-traded Trace-eligible bonds outstanding in 2012 dwarfing the number of listed companies on the U.S. stock market.

The average U.S. stock traded around 3,800 times per day in 2012, while the 13 most liquid U.S. IG and 20 most liquid HY corporate bond issues traded only about 85 times and 65 times per day on average, respectively.

The attributes most valued by the buy side – immediacy and anonymity – are better delivered through current favored channels than through match-based e-trading, according to McKinsey and Greenwich Associates.

Despite these barriers, the buy-siders surveyed by McKinsey and Greenwich Associates are cautiously optimistic about the longer-term future of corporate bond e-trading. In the U.S., respondents believe that 40% of corporate bond trading volume can eventually be executed electronically, while European respondents said 65%.

Few participants foresee a revolution in e-trading however. When asked about the next five years, 80% of those surveyed by McKinsey and Greenwich Associates said the multi-dealer request-for-quote (RFQ) platforms on which most e-trading has been conducted for years will continue to prevail.

Buy-siders are generally reserved about other e-market models. About 25% expect crossing systems to dominate in five years. The figure for singe-dealer platforms is lower at 10%, while fewer than 10% were enthusiastic about the prospects for exchange-operated platforms.

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