Corporate Bond Illiquidity to Remain
The liquidity imbalance in corporate bonds may remain for the foreseeable future according to consultancy Greyspark Partners.
Regulations forcing broker-dealers to hold more capital has reduced their ability to make markets and created a liquidity imbalance that has become acute for the 3,000 to 4,000 corporate bonds that make up tail end of the market according to Greyspark’s Trends in Fixed Income Trading report.
The size of the EU and US corporate bond market increased by 57% from $7 trillion between 2007 and 2013 but the volume of corporate bonds held on sellside balance sheets declined by 82% over the same period according to the report.
The study said: “Many market participants estimate that buyside firms in the EU and US absorbed between 96% and 99% of the sellside corporate bonds inventory.”
As a result buyside firms are struggling to find liquidity from the sellside for large size trades in many corporate bonds. Greyspark forecast that this year between 20% to 25% of corporate bonds will be traded electronically, the same as last year.
Russell Dinnage, senior consultant at GreySpark Partners told Markets Media that it is difficult to predict when this percentage will increase.
“There are a number of innovative solutions like Algomi which are only now being implemented so we are just at the beginning of electronic corporate bond trading,” added Dinnage.
Algomi, which builds internal social networks for banks to become more effective fixed income brokers, is adding buy-side firms this year.
Stu Taylor, chief executive of Algomi, told Markets Media last month that Algomi was a smart network which helps collaboration across the sales team within banks. for example, by finding out that someone spoke about a certain bond three months or three days ago.
Dinnage said: “It has been a difficult year from May 2013 to May 2014 for the uptake of corporate bonds trading platforms. It seems that, without the support of major broker-dealers, independent corporate bonds trading platforms are struggling to take up market share and succeed.”
In February this year Goldman Sachs cancelled plans to continue to develop GSessions, an electronic bond trading platform, while BlackRock announced in April last year that it was discontinuing the Aladdin Trading Network, the fund manager’s corporate bonds matching platform.
“A number of banks are taking up the challenge to electronically trade corporate bonds in new ways, and they are investing in new software solutions as well as in human resources to tackle that challenge as these investments can create new challenges for existing fixed income sales teams and trading teams, especially as new software disrupts long-standing, voice-traded, over-the-counter corporate bonds sellside dealing models,” added Dinnage. “Despite these challenges, a voice-traded element for corporate bonds dealing will remain in place for the foreseeable future.”
Last month a survey of over 200 senior buy- and sell-side market participants at the European Capital Markets Forum, hosted by Trax and MarketAxess, found that 58% of institutional market participants believe that there is not enough transparency in the European corporate fixed income markets.
Rick McVey, chief executive of MarketAxess, said in a statement: “Transparency and the cultivation of more open, competitive markets are the primary aims of both regulators and market participants. The survey conducted at our flagship European event shows that nearly two-thirds of market participants believe that there is currently insufficient transparency in the fixed income market, but there is still work to be done to create a suitable framework that does not negatively impact liquidity.”
Dinnage said: “Some large banks are experimenting with internalisation engines to match-off corporate bonds liquidity internally on bank balance sheets in an effort to utilise the corporate bonds liquidity remaining on those balance sheets more efficiently; these crossing or matching engines could be adapted in the future to become more generic corporate bonds dealing platforms, but the sellside still has far to go in order to achieve that goal.”
Greyspark has predicted that banks will have to change their businesses to adapt to the new world of fixed income and will form one of four models – flow houses, the large banks which require the ability to internalise fixed income flows on a balance sheet; prime brokers who focus on client risk management and collateral optimisation coupled with strong trade execution capabilities; risk takers and niche specialists.
Featured image via Shane Farnsworth/Lightstock
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The analysis is based on transactions publicly reported by 30 European APAs and venues.
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