Fixed Income Liquidity: Good Enough?

Terry Flanagan

For all the lamenting about the perceived liquidity crisis in the corporate bond market, institutional traders can, for the most part, do their jobs.

“My viewpoint is that liquidity in the market is fine, and the reason I say that is my definition of liquidity is, ‘the ability to transact in a security, in a reasonable time period, without significantly affecting the price of that security’,” said Alvin Burgos, U.S. head of sector manager trading at Deutsche Asset Management. “In the current market environment, you’re able to do that.”

Burgos will speak at Markets Media’s Fixed Income Trading Summit, to be held Thursday April 21 in NYC.

To be sure, sourcing liquidity is not easy, and the task is considerably less straightforward than it was years ago, when Wall Street brokers were the first and last calls. The landscape is fragmented, and traders often need to be creative and leave no stone unturned in the search for a suitable counterparty.

“If I’m putting money to work in the current environment, the main source of liquidity is the new-issue market,” Burgos told Markets Media. “We’re on pace for a third straight year of more than $1 trillion of issuance, and new issue purchases account for 35% of our trading volume.”

In the secondary market, old-fashioned voice trading accounts for about 40% of DAM volumes. “This is where we use our traders’ expertise and skillsets to add value, by getting the relative value trades on, and by sourcing liquidity,” Burgos said. “We can be liquidity providers for special names and situations in which we may have a deeper understanding of the credit or the sector.”

Alvin Burgos, Deutsche Asset Management

Alvin Burgos, Deutsche Asset Management

Burgos considers electronic trading platforms as ‘efficiency tools’, best for smaller transactions. “Their value is minimizing the time traders work on smaller axes or program transactions, and free up their time for more value-added transactions,” Burgos said. “Right now these platforms account for 20-25% of our volumes, but more than 60% of the tickets we write.”

E-platforms have their limitations, but overall the emergence of the space has helped freshen what had been a stodgy, old-line business.

“It’s helpful to see this renewed focus of technology being applied to different parts of the fixed income space,” said a market-structure analyst at a buy-side firm, who spoke on condition of anonymity. “We’re seeing clear efficiencies in matching buyers and sellers. That’s a net positive, for everybody.”

A possible drawback of trading platforms is that they will disperse precious liquidity. “You have the potential that liquidity will be spread out over many different venues,” the analyst said. “You don’t want a scenario where you have to go to the same number of exchanges and dark pools as you do on the equity side of the business. We’re not there in fixed income, yet, but that is one thing we are conscious of.”

The proliferation of bond trading platforms can be compared with the early 2000s, when a field of several dozen cropped up seemingly out of thin air, only to shrink almost as fast as it expanded.

The consolidation resulted in several industry leaders capturing significant market share. “I think you will end up seeing something like that here, where the existing platforms end up with almost a menu of protocols,” the analyst said.

“The key challenge in this market is that it is very institutional and it doesn’t have the same level of retail involvement as the equity market,” this source said. “The result is an element of correlated trading patterns, and the likelihood that you have buyers and sellers arriving to the market at the same time is relatively low.”

“Even if you can bring efficiency to the process of buyers finding sellers, ultimately, the market has always been dependent on dealer balance sheet to warehouse risk between trades,” the analyst continued. “That’s why in some respects, RFQ (request for quote) has continued to be important to the market, and you haven’t seen a very large shift to trading on non-dealer-intermediated platforms.”

As for the future, Burgos of Deutsche Asset Management expects the influence of trading platforms to expand, though the expansion may be only modest. “Broker-dealers provide a value proposition to the investment community, so they have a role in the market,” he said. Also, “a lot depends on what kind of regulations might be coming, and also the commitment firms are willing to provide these new electronic platforms.”

Featured image by siraanamwong/Adobe Stock

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