E-Trading Corporate Bonds - Problem Solved?

By Anthony J. Perrotta, Jr., TABB Group

Originally published on TABB Forum  

Things are heating up in the corporate bond e-trading kitchen. After almost two years of gathering the ingredients, the market may be on the verge of finally concocting the stew. In the past 14 months, we’ve seen prequels to a liquidity crisis that is bubbling, so serving market participants a solution is long overdue.

Since the financial crisis, electronic trading has risen dramatically. TABB Group estimates that approximately 15%-16% of the notional volume for investor-initiated (otherwise known as dealer-to-client, or D2C) trading now is executed via some electronic medium. Accounting for retail transactions, that number rises to approximately 21%. With four-fifths of the notional volume still transacted the “old fashioned” way, the stakes are high for those investing in the proliferation of the e-business.

Tradeweb Markets recently announced the launch of a new U.S. corporate bond trading platform for institutional investors. Normally, a singular announcement of a new trading platform would not move the needle and warrant a comment; but this development is significant, and there are different perspectives one can take in assessing its impact on the market.

A global titan in the building and operating of electronic marketplaces, Tradeweb has been down this corporate bond road before, with results falling short of its standards. The firm executes $350-plus billion notional and 35,000 individual trades on a daily basis across more than 25 fixed income markets. The cynic might suggest the firm simply is not destined to play a role in the U.S. cash corporate bond market, with its DNA rooted in rates, mortgage-backed, and derivatives markets. I will take a pragmatic view, concluding that the firm is focused on leveraging its resources, strengths, and extensive relationships and is committed to building a credible credit trading franchise over the long-haul. This is a significant development because the firm has an extensive network of proven pre-, at, and post-trade services already embedded in the workflows of more than 2,000 investors and 150 dealers.

Tradeweb adds a level of competition that ultimately is healthy for market participants on many levels. First, it validates the thesis that electronic trading is in the early stages of growth. Second, it creates an environment for innovation. Third, it provides consumers (investors and dealers) with choices. And finally, it creates downward pressure on execution costs.

So a behemoth enters the fray, joining incumbents MarketAxess, Bloomberg, and MTS/Bonds.com (owned by London Stock Exchange), while others such as Bondcube, Electronifie, ITG, KCG BondPoint, Liquidnet, and TMC Bonds are in the nascent stages of tackling the institutional corporate bond market. Their success will undoubtedly hinge on whether or not they are able to solve a problem. MarketAxess was successful in solving a workflow problem in 2002, when it introduced the list-based e-RFQ. Today, that mechanism dominates the electronic landscape, but it is proving increasingly ineffective at solving the current problem: finding liquidity in off-the-run corporate bond issues (which account for 99% of the market).

The Tradeweb platform brings a new ingredient to the stew: the ability to access streaming, executable prices from a wide array of dealers for round-lots sizes (>$1 million). Critically speaking, it’s unclear how the new protocol factors into the solution for the current liquidity conundrum. Irrespective, the commitment of the firm is unquestioned and the process of arriving at an appropriate solution will be a constructive, albeit iterative process.

Ultimately, solving the liquidity problem may extend well beyond the capabilities of execution venues, as our research indicates structural issues are the root cause of the problem. The market is sitting at a critical inflection point; institutional investors are taking note. Blackrock, the market’s largest asset manager, recently published a piece entitled, Corporate Bond Market Structure: The Time for Reform Is Now, in which it lays out a case for increased interconnectedness, an expanded ecosystem of trading protocols, standardization of corporate bonds, and behavioral changes on the part of market participants. The last of these four points is the one that is most elusive and the most sorely required.