Buyside traders say they are still finding liquidity from traditional voice dealers in the corporate bond market, though they will increase their usage of electronic venues for small trades to boost efficiency.
Despite concerns about a looming liquidity crisis and sellside balance sheets constraints, head traders speaking at an industry conference sponsored by Tabb Group said they mainly rely on voice traders to meet their liquidity needs.
Though the panel discussion was focused on the liquidity conundrum and the development of electronic bond trading networks, buyside traders said the market is working fine and they are not in a panic over a potential liquidity crisis.
There are people confused as to where we are now and where they think we will be if we dont see some automation or electronification of the market, said Michael Nappi, VP Investment Grade Trader, Investment Grade FI at Eaton Vance. He said liquidity weaknesses do not affect all issues and sectors.
The easier trades are actually easier now than theyve ever been to do, said Nappi, attributing this to order management system tools. Problem areas are the small issues, off-the-run bonds such as one with a maturity of 2032. These are as difficult as theyve ever been, he said.
Amy Koch, managing director, head of fixed income trading at Standish Mellon Asset
Management Company, suggested that the media is blowing the liquidity shortage out of proportion. I dont think that liquidity is down to zero and balance sheets are down to zero in the way they are made out to be in the press, said Koch. I dont think its that bad and Im on the front lines every day.
While acknowledging later on that sellside balance sheets are scarce, Koch conveyed its the relationships with dealers that enables the buy side to move large size.
The voice market for us, whether you are going to one, three or five dealers is really what helps paint the picture for what you are trying to do, said Koch on the panel. It really helps you gather information; it helps you form relationships.
The bulk of trading in the $7 trillion U.S. corporate bond market is dealer-to-client through voice and through request-for-quote (RFQ) platforms, where the buyside submits queries for bids and offers to the sellside based on their credit relationships.
But the market is poised for change as the Federal Reserve is preparing to raise interest rates.
Some market participants worry that a Fed move will precipitate a mass exodus from corporate bonds through a small door, and this is putting pressure on the market to seek alternative liquidity sources and to experiment with new fixed income trading protocols.
Were in a very dynamic moment. You need to see the sponsors of this event to realize there are plenty more offerings with response to trading protocols than there have been for a long time, said Paul Reynolds, CEO of Bondcube, a new electronic trading venue that offers an all-to-all model among the sellside and buyside. Reynolds compared the situation to 15 years ago when during the dot.com boom there were 100 bond platforms. According to Tabb Group analyst moderator Radi Khasawneh, the current tally of fixed income venues is closer to 40.
Even so, buyside panelists appeared skeptical of whether a new wave of electronic bond trading venues could solve the market structure problems. However, many of the sponsors of the industry conference including Tradeweb, Bloomberg, Liquidnet, Bondcube, Electronifie and
TMC Bonds represent the rise of the machines. Tabb Analyst Khasawneh likened the process to using Internet travel sites like Expedia to booking a simple vacation. But if one had to book a complex honeymoon, they might call up a travel agent, he said.
Some of the new bond platforms are pushing a central limit order book (CLOB) model for allowing all to all trading between the buy and sellside as well as buy to buyside. But
Constantino Antoniades, head of fixed income at Liquidnet, which acquired the Vega Chi platform, pointed out that combining the voice and RFQ components is unlikely to result in the right market structure. It needs something else, he said. When there are 30,000 issues facilitated by a small number of dealers – that is a big problem.
Talking to Dealers & Moving Size
Everyone is trying to evolve and use more electronic trading, because [if] you use it it has to be more efficient, said Koch. Its feasible to throw all the smaller trades – round lots, $5 million and under – on an RFQ electronic model, she said. This would help the compliance team see all the bids covered by the system. But if an institution is trying to move $10 million of an illiquid bond, they would not get all the information and they might end up getting hurt, she said. You would never be able to show that kind of size on an electronic platform.
If the buyside showed large size on an electronic venue, they would hurt the dealers who are positioning on their behalf and who are selling on the opposite side, Koch cautioned.
There is room for electronic tools to increase inefficiency, said Dwayne Middleton, executive director, head of U.S. fixed income trading, Morgan Stanley Investment Management. Citing order management systems, the head trader said OMSs could flash to notify the buyside if theres a match. As far as RFQ systems blasting out terms, Thats not going to solve a liquidity problem because it goes back to capital, said Middleton. But MSIMs head trader sees an opportunity for electronic systems to improve information that is not being captured on messaging systems.
Buyside panelists on an earlier panel discussed receiving thousands of messages from
Bloomberg Messenger and needing to aggregate them electronically. Just knowing whats going on is a daily challenge, said Bondcubes Reynolds, a former bond trader. With tens of thousands of diverse securities in their portfolios, knowing where bonds are trading, their price, volume and whether they have liquidity is quite difficult in fixed income, he said.
A Different Mindset on Buy Side
Different fixed-income protocols require the buyside to act as market makers go against the way they are organized, according to several traders on the panel. On different trading desks, some have full discretion, some are making markets, while others lack discretion, says Eaton Vances Nappi.
Its a different mindset for the buyside, said MSIMs Middleton. Unlike market makers, the orders on a buyside traders screen are client assets. Its not inventory, explains Middleton.
A firm may be a natural buyer of securities, but not a natural seller, he points out. I think its going to be difficult internally to make two-sided markets and get over that hurdle as well, he said. Also, there are rules against buying and selling the same security on a given day across portfolios, noted Middleton.
Regardless of the hurdles, Nappi sees an all-to-all model developing eventually. The phone is going to be a big part of it. Though he doesnt think hell be calling another buyside trader to write tickets, Nappi said, The existing model can exit with some enhancements. Youre starting to see the sellside embrace electronic trading because the buyside volumes have shot up.
We could never go back to an all voice model, he said.