Shrinking Dealer Inventories Spur Electronic Bond Trading

Terry Flanagan

With dealer corporate bond inventories down by almost 80% since 2007, institutional investors are actively seeking new sources of fixed income liquidity.

“As a result of regulatory changes, as well as general de-leveraging from risk aversion post financial crisis, dealer inventories have been declining,” said Michael Chuang, founder and chief executive at itB Holdings, a software provider for institutional fixed income traders.

Centralized, electronic venues for the execution of corporate bonds are gaining traction as the industry faces a series of regulatory mandates coming off the Dodd-Frank Wall Street reforms, most immediately the Volcker Rule.

“After the financial crisis, proposed regulatory changes made it more difficult for dealers to hold inventory,” said Chuang. “Two of the most influential were the Volcker Rule, limiting a bank’s ability to participate in proprietary trading, as well as Basel III, which increases capital standards for banks that hold risky assets.”

In the cash markets, global bond markets will likely be severely impacted by new liquidity requirements.

“The buy side will be under time pressure to comply with impending regulations and to adapt to new trading venues for financial products previously traded by voice,” said Jonathan Fieldman, chief operating officer at Broadway Technology, a trading technology firm.

“The technical implications of these shifts in the market will be challenging for many buy-side participants.”

Institutional investors have supplanted dealers as the main participants in the corporate bond markets, and that has fueled demand for trading venues on which they can access liquidity from other buy-side firms.

“Institutional investors need to find a way to replace the liquidity that is lost from the absence of traditional dealers,” said Chuang at itB Holdings. “Bond trading platforms offer institutional investors the ability to engage in a much greater number of buyers or sellers than before, thus improving efficiency and trade execution.”

iTB Holdings has launched iTBconnect, a platform that connects institutional investors to electronic fixed income trading venues.

iTBconnect utilizes advanced order processing and routing logic that significantly improves best execution capabilities, the company said.

“iTBconnect’s value proposition is in the product’s ability to create an efficient workflow for institutional fixed income traders,” Chuang said. “This increase in workflow efficiency improves order management, trade execution and post-trade processing.”

A plethora of new platforms are trying to solve the issue of sourcing liquidity.

Vega-Chi US is launching its U.S. high-yield bond electronic trading platform, which 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.

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.

Tradeweb Markets has introduced Central and Eastern Europe, Middle East and Africa (CEEMEA) bonds to its electronic cash credit marketplace.

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.

“Although it’s currently a difficult environment for credit markets, more than 85% of volume on the platform is executed by real-money institutions, such as asset managers, that continue to seek greater efficiency in the trading of cash credit bonds,” said Rupert Warmington, director of European credit markets at Tradeweb, a provider of electronic marketplaces, in a statement.

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