A Liquidity Mosaic
In September 2013, Verizon Communications sold $49 billion of bonds in the biggest-ever corporate-debt offering. Some of the eight tranches, including $15 billion of 30-year bonds and $11 billion of 10-years, have so many secondary-market buyers and sellers that some observers say the bonds are suitable for a dark-pool or crossing-network mechanism typically found in equity trading.
But that’s the exception in the broad and highly disparate corporate-bond market, as below the rarefied air of the most liquid names, there are countless issues with sizes ranging down from 10 billion, to $1 billion, to $100 million and less. A buy or sell order in a smaller bond can sit on a platform for weeks or months without finding its ‘other side’, so different trading mechanisms and protocols have — amid regulatory change and technological advancements — emerged to address the liquidity gaps.
“Different trade sizes call for different business models,” said James Wangsness, president of fixed-income marketplace TMC Bonds. The suitability of a business model “depends upon the needs of the underlying client, as well as the service provider or platform,” he said.
In U.S. fixed-income markets, Wangsness said trading protocols include exchange-like trading akin to a central limit order book; ‘click-to-trade’ on live, executable prices; request for quote; sessions trading; order book/matching; and voice.
There are a host of factors that influence which protocol is indicated for a given trade. These include the market demographic of the counterparties (e.g. retail or institutional, inter-dealer broker, ‘Tier 1’ bank, asset manager); which segment of the market is being traded (e.g. investment grade or high yield), trade size; regulation and compliance issues; and the capacity and limitations of technology.
To underscore that many corporate bonds rarely if ever trade, more than 90% of corporate-bond trading volume is generated from just the most liquid one-fifth of bonds, according to industry estimates.
Aside from regulation and technology, macroeconomic conditions have also helped beget the current liquidity framework in corporate bonds. Some market observers characterize this framework as a patchwork of layers, none of which can provide enough liquidity to the market on their own, but can do so in aggregate.
Specifically, the global financial crisis of 2008-2009 substantially impaired liquidity, the depth of which has yet to recover.
Jesse Fogarty, managing director at Cutwater Asset Management, explained that big banks provided the lion’s share of liquidity in the 1990s and early 2000s, and hedge funds challenged that supremacy around the mid-2000s. The financial crisis and ensuing wave of regulation have diminished both groups, opening opportunities for smaller trading platforms and innovative business models aimed at provisioning liquidity.
“Valuations have repaired from the depths of 2009, but liquidity hasn’t really returned,” Fogarty told Markets Media. “Liquidity is challenging, there’s no doubt about it.”
Fogarty noted that a number of large firms, such as BlackRock and Pimco on the buy side and Goldman Sachs on the sell side, developed their own trading systems, with limited success. “They didn’t really ‘crack the code’, but it’s a work in progress,” he said.
The post-crisis liquidity landscape “is certainly a new paradigm,” Fogarty said. “There’s less ability, and less willingness” on the part of the sell side to provide liquidity, he said. Also, the buy side has consolidated, which has resulted in less dispersion of opinions and by extension, less liquidity.
Cutwater trades corporate bonds electronically mostly through MarketAxess, and Treasuries through Bloomberg. In Fogarty’s view, corporate-bond liquidity stands to improve with time as certain trading platforms emerge as winners and the field of winnows.
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