Electronic bond platforms become more treasury friendly as liquidity shifts.
With banks shunning their deposits, unfolding regulations making money market funds less agreeable, and more interest-rate hikes anticipated, 2016 is destined to present new investment challenges for corporate treasuries, but a splash of new platforms to trade fixed-income may help facilitate trades on the bond front.
US Treasuries and agency bonds have long traded over electronic platforms such as Tradeweb and MarketAxess, providing easy access and often cost savings.
Trading corporate bonds and asset-backed securities, which the treasuries of cash-rich corporates have ventured into in search of yield, has been much more difficult over such platforms because of the bond market’s fragmented nature, with more than 70,000 cusips compared to the equity market’s 3,500 individual tickers.
Apart from 400 or 500 highly liquid bond issues, finding counterparties using the platforms’ agency model can require posting orders for significant time periods, even days, raising the risk of adverse price moves. Consequently, broker-dealers have retained their role as intermediaries, using their capital to facilitate the vast majority of bond trades—until recently.
Basel III and other new regulations have prompted dealers to slash their securities inventories to a third of what they were before the financial crisis, and they’re much less willing to commit capital. In fact, asset managers and other institutional investors now hold the bulk of the securities, prompting a rash of new electronic trading platforms to emerge over the last year or two as well as new offerings from the existing platforms to fill in the gap.
“The platforms are developing different protocols to unearth liquidity, and more importantly utilizing the network effect to connect people, much like social media,” said Anthony Perrotta, head of fixed-income research at consultancy Tabb Group.
That means moving away from the traditional model of sending out requests for quotes (RFQs) through a broker to a limited number of potential counterparties, an approach that until recently the electronic platforms simply made more efficient, toward seeking trades with a broad swathe of potential counterparties, often directly with buyside particpants, where much of the liquidity now resides.
The electronic platforms now execute 15 percent to 20 percent of corporate bond trades, a relatively small share, and upwards of 80 percent of that volume is done over MarketAxess, Founded in 2000, it is one of the early players in the space and was also early to recognize the importance of bringing potential buy-side counterparties directly on to its platform. In 2010 it introduced its Open Trading protocol, which enabled sending RFQs out electronically to both sell-side and buy-side participants, although early on transactions still had to be completed through a broker, usually over the phone.
In 2013, MarketAxess became a potential counterparty in trades, enabling participants to trade with each other directly and electronically, with buy-side or sell-side participants. Now a corporate or other institutional investor can send an RFQ to multiple broker intermediaries they have relationships with on a name-disclosed basis, or they can send it out anonymously to MarketAxess’ entire network of brokers and institutional investors using the Open Trading protocol.
“It lets the institutional investor get the best of both worlds—using the traditional approach or accessing this new source of liquidity that augments what’s already available to them,” said Richard Schiffman, Open Trading product manager at MarketAxess. “We line up the responses from best to worst, and a trade can be completed either the traditional way or anonymously through an alternative liquidity provider.
At $23 billion in the third quarter, Open Trading volume was a bit less than 10 percent of MarketAxess’ total volume of $240 billion. MarketAxess’ average trade size is $700,000, but 30 percent of its overall volume comprises trades of $5 million or larger. Through September, the platform averaged $2.3 billion daily in investment-grade trades, and $436 million for high yield.
Tradeweb, another long-time trading platform specializing in fixed-income products and related derivatives, began trading corporate bonds in October 2014. Its daily average trading volume for investment-grade bonds is significantly less than MarketAxess’, but the platform, especially strong in Europe, trades a wide variety other investment products as well, including money market funds, exchange traded funds and equity derivatives.
Tradeweb’s trading protocols include focused RFQs and Blast RFQs that allow clients to request quotes from many or all dealers on our platform. Tradeweb’s average trade size in 2015 through September was $2 million and Tabb Group notes that its 50-plus inquires on average daily translate into 30 to 50 trades, a high execution rate.
Chris Bruner, head of US credit product at Tradeweb, attributes the relatively large size of its trades and high execution rate at least in part to integrating several sources of the pre-trade information on its platform, including streaming prices, real size and indications of axes from dealers.
“We’ve tried to do good job of integrating all that information into one place,” Mr. Bruner said, adding, “So you can see inventory and interest from dealers indicating that they want to trade with you streamed directly into the platform, along with prices they’re streaming via APIs.”
Similar to MarketAxess and other electronic bond trading platforms, Tradeweb can be connected to corporates’ back end systems, such as an order management system, so a treasury executive can place an order, agree to terms of a trade, and the related trade data automatically flows to its own system and the counterparty’s.
The bond platforms, now numbering more than 20, typically provide customers with anonymity, control over who RFQs are sent to on a name-disclosed basis, or both, and in a variety of formats. The platforms are not only investment tools but a way to repurchase bonds, without an intermediary and in some cases completely anonymously.
“The Fed uses them all the time with agency mortgage-backed bonds and US Treasuries,” Mr. Perrotta said.
Liquidnet, for example, was one of the early equity-market “dark pools,” providing a buyside-only environment where institutional investors can indicate interest in pursuing a trade without disclosing their identities or whether it’s a buy or sell order. It launched a fixed-income dark pool at the end of September and by mid-December counted 230 users from 125 institutions, and since it has more than 800 institutional clients trading in its equity that likely also trade fixed-income, it anticipates those numbers climbing rapidly in 2016.
Constantinos Antoniades, Head of Fixed Income at Liquidnet, said the dark pool’s volume of posted indications recently bumped up from $4 billion daily to closer to $5 billion, with orders averaging $5 million in size. He declined to say how that translates into trades, noting that information goes out first to clients as per Liquidnet’s policy.
“Our clients are not here for immediacy; they’re looking for natural liquidity,” Mr. Antoniades said. “Our dark pool allows our clients to match passively with minimum effort with opposite natural institutional liquidity while keeping their order information fully protected.”