Bond trading poll - Kings of credit and liquidity

A handful of players dominate the major bond-trading disciplines. Deutsche Bank heads Eurobond and government bond trading and leads the field in many of the separate credit products. Warburg Dillon Read, ABN Amro and Morgan Stanley Dean Witter are close on Deutsche's heels.

But honours for the most progress among the top players would have to go to MSDW. It has shown that it's possible to break into new territory with some impressive leaps forward in corporate bonds, sovereigns, bank and government bonds.

David Cohen, head of investment-grade trading at MSDW, is not surprised. "Though few people would be surprised at our top ranking in US dollars, the sterling market was not considered to be a traditional strength for us. But a tremendous push into the market headed by Darren Bowler has brought excellent feedback from customers."

In the euro market, particularly in trading euro straights, MSDW also saw significant upgrading, which, says Cohen, "reflects the focus and emphasis that both our sales force and capital markets professionals, in addition to the trading desk, have placed on the euro currency. In particular, we have refocused our efforts on the more credit-intensive section of the market (single-A and triple-B), and redeployed some of our strongest traders - Franck Sylvain, Christophe Greffier and Ric Ford - to the area. As the euro market continues its explosive growth we are determined to take advantage of these volumes, and to continue to provide liquidity to our customers."

Providing liquidity for the emerging European corporate bond market is a priority for the year ahead. Volumes of new issues by European corporates more than doubled in a year, from $57 billion in 1998 to $137 billion in 1999. But there's still not much liquidity in anything other than triple-A bonds. "There is only a limited capability today for investors to go to multiple dealers for prices in any given bond," says Kevin Brolley, managing director and head of European fixed income sales at Chase Manhattan, "as many market makers are reluctant to provide liquidity in issues they have not themselves placed." To provide more value for investment-grade, and high-yield investors, Chase now has 15 people in its credit research team, built from scratch two years ago.

Building a strong credit research team is an urgent task everywhere in the business, stemming from the recognition that trading corporate credit requires fundamentally different skills from trading government bonds. ABN Amro, for example, will also provide more in-depth information to its customers, based on analytical research, says Amr Mounib, global head of credit trading at ABN Amro. "This will require a more sophisticated approach, which will ultimately come to resemble the equity trade. As you have to hedge telecom credit with another telecom credit, the euro corporate market will develop on a sectoral basis. We have already aligned our trading and research accordingly. And from a risk management point of view, the ultimate way forward is one desk for all corporates."

Other banks are more or less heading the same way. MSDW restructured its euro credit desk at the beginning of 1999, by separating trading of credit-intensive issues from arbitrage-type issues.

In February this year, Deutsche Bank set up a liquidity group and a credit group. The former, headed by Wolfgang Matis and based in Frankfurt, trades government, agency, sovereign, supranational debt and Pfandbriefe. In London, Brian Reid and Steve Renehan are co-heads of the credit group, which comprises corporate, financial and high-yield debt.

In high-yield credit, Euromoney's latest poll records a big leap by CSFB. "Our dedication to secondary trading in the Eurobond markets, and in particular to the high-yield business, has paid off," concludes Eraj Shirvani, head of European and Pacific credit trading. "This month we are also introducing the Liquid Eurobond Index, comprising 600 issues across the high-grade dollar, sterling and euro market. But the challenge ahead is not only to continue to provide liquidity to customers in volatile markets across the credit spectrum. It is crucial to efficiently integrate online trading into our operations." CSFB's trading system PrimeTrade will be made available to its customers for investment-grade Eurobonds.

Autobahn to be extended

Deutsche's own-label electronic distribution system, Autobahn, which already offers pricing for all liquid US dollar and euro-denominated bond products will be further extended to provide live prices in less liquid credit product in institutional size in the next month or so, says Brian Reid, co-head of credit trading at Deutsche Bank. "This will tie in well with our participation in multivendor systems such as MarketAxess. Liquidity and transparency are major problems in the credit markets and automation should help to improve this. However, for it to be successful, traders must support the concept."

Apart from extending its in-house distribution system, Deutsche's e-commerce strategy for fixed-income products involves providing liquidity to the market, via brokerage EuroMTS, and participating in the trading website BondClick.com. BondClick.com was founded in January by Deutsche Bank, ABN Amro, BNP Paribas, Dresdner Bank, JP Morgan and Caboto and will allow investors to check prices and trade eurozone government bonds from multiple dealers on one site.

Electronic interdealer brokerages have mushroomed, for example EuroMTS and BrokerTec, run by a consortium of investment banks, or the Bloomberg, Cantor Fitzgerald and Instinet bond-broking systems, as well as online trading systems such as the US-based TradeWeb. CSFB's Shirvani doubts that the market will support 10 or 12 trading systems over the long term. "But in the interim, the proprietary systems of banks will gain essential market share."

The growing variety and use of electronic trading platforms has been the single most important development over the past year. Although it's yesterday's news in other markets, electronic trading has yet to transform the costly and time-consuming operations of the fixed-income markets. Not only will electronic trading cut costs, increase the transparency of pricing and ease access to all players of the market, but it will also take off fast.

Electronic trading is central to Deutsche's liquidity business. But apart from efficient electronic distribution, says Wolfgang Matis, global head of fixed income products at Deutsche, the quality of advice given to customers counts towards Deutsche's success in the liquid markets. Deutsche takes the first place in government, sovereign and agency/supranational trading. "We manage to coordinate issuer targets with customer demand, and see ourselves as intermediary between issuers and investors in all markets," says Matis. "The high degree of pricing capabilities to facilitate that role can only be achieved if you trade all liquid bonds as a homogeneous product rather than manage risk on a single market basis," he adds.

Shrinking state debt

Budget surpluses, notably in the US, Canada and the UK, caused the biggest shift in government bond market volumes and liquidity. Bond buy-backs and reduced issuance have particularly reduced liquidity in the US government bond market. The US Treasury's decision to cut 30-year supply, prompted panic-buying by traders and investors, driving down yields on long-dated bonds. At one point, the 30-year was 50 basis points through the 10-year benchmark. "The market has seen tremendous volatility even without significant moves in interest rates," says Kurt von Uffel, managing director of euro government trading at MSDW. His team adapted to the new situation by taking less outright interest-rate risk, and more risk along the curve. Also, as customer relations become more important in a less liquid market, the focus will be shifted there.

A further development that followed from the government buy-backs was a new global issuance programme initiated by Fannie Mae. "The process of agencies developing their benchmark programmes will continue," says Richard Johnson, head of syndication at Warburg Dillon Read. "Agency debt is an excellent surrogate for US treasuries, appreciated by institutional investors globally and also by corporate traders who use the larger issues as hedging tools." Participation in the reference bill programme and acting as bookrunner on the Freddie Mac reference note programme "have been crucial in terms of enhancing our profile in the agency market", explains Johnson.

Whether Fannie Mae and Freddie Mac bonds do become the key trading instruments of the future remains to be seen. "Yes, there is an increased focus on agency debt, and we will devote a lot of attention to it," says von Uffel, "but it will not completely become a benchmark in the way that people thought. I would consider them more of a credit product."

A bill in the US Congress, which seeks to tighten the regulatory oversight of Fannie Mae and Freddie Mac, has confirmed that feeling. Congress wants to ban the agencies from buying predatory loans, while the US Treasury would like to see the implicit government backing cut.

Meanwhile, the future of Europe's government bond market looks a little brighter: at least until 2002, according to von Uffel's estimate, when more of Europe's countries should be eradicating their budget deficits.