Corporate Bond Platforms Embrace Agency Model

Terry Flanagan

Centralized, electronic venues for the execution of corporate bonds are gaining traction as the industry faces the first in a series of regulatory mandates coming off the Dodd-Frank Wall Street reforms, most immediately the Volcker Rule, which aims to clamp down on the more speculative investments by banks.

“The inability for banks to commit capital, the likely impact of the Volcker Rule, and the collapse in levels of inventory held by dealers, are forcing a seismic shift in market structure,” said Constantinos Antoniades, chief executive of Vega-Chi US, an electronic bond trading platform.

With dealer corporate bond inventories down by almost 80% since 2007, institutional investors are actively seeking new sources of fixed income liquidity. This, combined with the recent proliferation of new electronic fixed income trading venues, has created an overly fragmented market.

“Institutional investors are now the main participants in the corporate bond markets, not dealers,” Antoniades said. “Not surprisingly, they are calling for trading venues on which they can access liquidity from the true holders of corporate paper—other buy-side firms.”

Next month, Vega-Chi US will launch its U.S. high-yield bond electronic trading platform for institutional investors.

The Vega-Chi trading platform enables institutional investors to trade directly with each other in an exchange-like electronic setting without the need for intermediation by a broker-dealer.

Vega-Chi will launch with more than 45 institutional users and expects the number of participants to exceed 80 within the first three months of trading.

The need for an exchange-like facility is driven by the concern that large money managers have regarding the ability to transact positions as trading moves from a principal to an agency-based model.

“The fallout from regulatory reforms such as Dodd-Frank, Basel III [bank capital adequacy rule] and the Volcker Rule is declining dealer liquidity,” said George O’Krepkie, president of Bonds.com, an online alternative trading system and licensed broker-dealer. “A plethora of new platforms are trying to solve the issue of sourcing liquidity.”

The fixed income space has lagged significantly in integrating the benefits of advanced technology when compared to other financial instruments.

“The last major technology innovation in fixed income was the RFQ [request for quote]” said O’Krepkie. “The industry is now demanding an agency-based electronic approach.”

Bonds.com is a centralized marketplace for the real-time electronic trading of U.S. dollar-denominated fixed income products, providing access to liquidity and execution on an agency basis.

Bonds.com displays live and executable orders rather than requests for quotes. Bonds.com drastically reduces the cost of supply meeting demand.

“This is achieved by matching buyers and sellers in a fair and equal electronic trading environment via a centralized order book,” said O’Krepkie. “The net result for all clients is the opportunity to achieve best execution.”

Vega-Chi launched a multilateral trading facility in Europe for convertible bonds in 2010, followed by a high yield/subordinated bank debt platform in Europe in 2012. The European platforms have approximately 100 participant buy-side firms.

Transatlantic exchange operator NYSE Euronext’s bond trading service, NYSE Bonds, employs an order book in which firm and executable orders are placed on the book on a price/time priority basis.

The service is highly appealing to the U.S. retail brokerage community, and with U.S. demographics favoring more fixed income holdings, it could prove popular over time, according to a recent report by research firm Celent.

Electronic platforms in the cash fixed income markets include RFQ-based and order book-based dealer-to-customer (D2C) models, such as Tradeweb, MarektAxess, Bonds.com, and Vega-Chi, as well as dealer-to-dealer (D2D) platforms and single-dealer platforms.

Goldman Sachs has launched G-Sessions, which holds twice-weekly auctions, and Morgan Stanley is planning to launch a similar service, called Bond Pool.

“The market is well served by the D2C model,” said O’Krepkie. “If I need to do a million active bonds, I can do so safely electronically.”

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