09.11.2013
By Terry Flanagan

Obstacles to Electronic Bond Trading Assessed

Corporate bond markets face a number of obstacles on the road to becoming fully electronic, in particular the fact that unlike the order-driven equities markets, they have historically been quote-driven, according to research by McKinsey and Greenwich Associates.

According to the research, which involved an online survey of 117 buy-side portfolio managers, traders and analysts in the spring of 2013, plus individual interviews, true corporate bond e-trading is a long way from becoming reality.

“While e-trading will undoubtedly play an important role in the future of corporate bond trading, structural realities stand in the way of attaining the order-driven nirvana that the cash equities market has achieved,” according to the report by Roger Rudisouli, partner at McKinsey and Andy Awad, managing director at Greenwich Associates.

Corporate bond markets in the aggregate are unsuited to e-trading, said the report, and the market participants surveyed and interviewed were dubious about the prospects for bona fide match-based e-trading.

“The fact that fixed income volumes are drastically smaller than equity volumes is not news,” said Michael Chuang, CEO of iTB Holdings, which operate a fixed income electronic trading platform that connects to multiple trading venues. “Because of these nuances of fixed income, certain forms of electronic trading aren’t likely to be exact replicas from the equity markets in terms of electronification.”

For instance, it’s unlikely there will ever be high frequency trading in corporate bonds, as there is in liquid securities such as US Treasuries, said Chuang. Nor is it likely that all corporate bonds will 100% centralized and traded on any one or few particular venues.

“The corporate bond market is too big and the asset class too wide for the entire sector to share the same characteristics,” he said. “Evaluating them as one single asset type will undoubtedly yield results that make electronification appear less likely.”

Still, said Chuang, “There are certainly lots of corporate bond issues that are liquid and have adequate trading volume where leveraging technology can make the trading process tremendously more efficient for investors. We know this because our estimate is that close to 50% of the daily corporate bond trades involve some sort of electronic connectivity.”

When asked about the next five years, 80 percent of the respondents in the McKinsey/Greenwich Associates study said the multidealer request-for-quote (RFQ) platforms on which most e-trading has been conducted for years will continue to prevail.

A relatively high number (25%) expect crossing systems to dominate in five years. In April 2013, BlackRock’s Aladdin Trading Network and MarketAxess launched a partnership to reduce liquidity fragmentation and improve pricing across credit markets, while expanding both firms’ open trading efforts.

The alliance evolves Aladdin Trading Network into a fixed income trading portal that consolidates fragmented liquidity for the benefit of Aladdin clients. MarketAxess will run electronic trading and broker dealer operations, including multi-dealer RFQs and electronic order matching, which will be connected to BlackRock’s Aladdin.

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