Electronic Bond Trading Takes Root Among Buy Side

Terry Flanagan

Electronic trading continues to grow across the fixed income sector. In a market that was previously dominated by direct relationships between buy- and sell-side traders, the industry is beginning to rely on some of the emerging technology trends that have taken shape in other asset classes.

“Over the past 12 months, we’ve seen a change in how institutional investors are trading in corporate bonds,” Michael Chuang, founder and CEO of iTB, which provides an electronic trading platform to institutional investors, told Markets Media. “There are pockets of clients that have become very active and started to change the way they trade and look at the market.”

Within fixed income, the factors that have driven adoption of electronic trading in other asset classes– direct access to real-time market data and greater access to liquidity pools—are beginning to take root.

As opposed to the old days of calling hundreds of brokers for current market data, data is now available streaming real-time via electronic platforms. “We are now able to stream thousands of CUSIPs directly into their web interface or their Excel models,” said Chuang. “This is a completely different way of trading compared with either request for quotes or using the phone.”

By utilizing trading platforms, investors gain the ability to tap into retail electronic communication networks, which were almost unreachable before, but provide greater levels of liquidity.

“All the activity we’re seeing is in both high grade and high yield corporate bonds,” said Chuang. “That seems to be where the biggest changes are occurring in the cash fixed income market.”

Low rates and a lack of volatility have kept fixed-income trading volumes low and left a number of dealers and investors on the wrong side of the market as rates declined.

Five of the six biggest U.S. fixed-income dealers saw an increase in market share over the last year and the collective market share held by the top five sell-side firms increased to 57% from 53% a year ago, according to Greenwich Associates.

“We’re seeing a greater concentration of share among the top banks as buy-side customers try to stay as relevant as possible with the big banks,” said Greenwich Associates consultant James Borger. “But we are also seeing investors seek out liquidity by adding more dealers to their list of counterparties, especially as a few banks have reduced their commitment to the space.”

New, tougher capital reserves requirements mean that dealers are more constrained as to how much inventory they can carry and how much liquidity they can provide. New regulations have also sharply increased compliance costs as banks were forced to hire hundreds of compliance officers and upgrade IT systems.

Four global banks – Goldman Sachs, Deutsche Bank, Citi, and J.P. Morgan – are essentially deadlocked atop the U.S. fixed-income market for overall market share, which is driven by volumes in government bonds, interest-rate derivatives and MBS pass-throughs (together accounting for more than 80% of total volume covered), according to Greenwich Associates.

These four banks capture shares between 11.4% and 12.1% in overall volume over the past 12 months, leaving them in a statistical tie for the leading spot, while Barclays rounds out the top 5 with a market share of 10.3%.

Chuang said, “It’s harder to get bigger trades done. The lack of volatility has created an earnings downfall for anyone who is in the fixed income market making business. Bid offer spreads haven’t widened much because of low volatility.”

Featured image via iStock

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