Not enough trade for Volcker
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Not enough trade for Volcker

Will Paul Volcker, author of the rule that has banned banks from proprietary trading, now stand up, perhaps beside Gary Gensler, recently departed head of the Commodity Futures Trading Commission, and lambast banks for not trading enough?

On the day after US regulators approved the final draft of Volcker’s eponymous rule, Euromoney hosted a webinar on the crisis of illiquidity in the bond markets. An audience of 168 mainly institutional investors listened as Dominic Holland, director of credit and e-commerce sales at Deutsche Bank, Constantinos Antoniades, founder of electronic bond trading platform Vega-Chi, and Niall Cameron, global head of credit trading at HSBC, discussed the need for a change in market structure.

Investors have consolidated and grown bigger in recent years; low policy rates and bank deleveraging have fuelled growth in bond market outstandings, all while regulation has reduced the capital that banks can put to work to turn this raw material over. Tabb group data show dealer corporate bond inventories have shrunk to just 20% of their pre-crisis high of $240 billion, and now run at under $50 billion, or just 3% of market outstandings, down from 16%. Few of the 40,000 or so corporate bonds outstanding trade actively, with just 323 bonds, a mere 1.6% of the market, turning over on 250 days of the year or more. Two-thirds of US corporate bonds see fewer than 20 trades in a month. It’s a big problem hiding in plain view.

The extent of this decline has been obscured by what Holland calls a liquidity mirage, where a large amount of unreliable pre-trade price information, with dealers streaming thousands of prices through dealer-to-client platforms, disguises how little actual trading takes place. The Volcker Rule requires banks engaging in market-making for customer facilitation to show that, rather than being disguised carry-trade investing, this activity derives from a demonstrable analysis of historical customer demand to buy and sell securities.

It would seem that by this metric dealers are trading far less than customers require.

And this will only get worse. As more bonds become illiquid, the chances grow of wide gapping in price on low secondary volumes driving up volatility and with it dealers’ requirement to post large amounts of expensive capital against stressed value at risk. It is self-reinforcing.

Perhaps it’s expecting a bit much that regulators will now badger banks to trade more to preserve the bond market as a vital source of capital for the real economy. But the realization is growing that the old bond market model of investors selling and buying from a small group of dealers that take principal positions as central liquidity providers is no longer sustainable. Holland gave an update on the so-called Oasis project in which a number of dealers are talking to software providers about a matching engine that will allow holders of seasoned, illiquid bonds to search for other investors seeking to buy the same or similar securities.

The shift to all-to-all trading, in which investors display indications of interest and live prices alongside other asset managers as well as bank dealers on exchange-like platforms, allowing price discovery through central limit order books, is almost upon us.


The bond market’s old order, the largest dealers with high market share, have been hoping it wouldn’t happen. And even today, when Euromoney asked the buy-side audience how much of their business they put through such platforms, 86% said less than 1%. But among those that have embraced change, new ways of trading take up a growing portion of secondary business. Some 14% of investors put more than 5% of their business through such platforms. What’s more, as many as 62% say that they are willing to display axes and live orders to encourage liquidity from other buy-side firms. One year ago, just a fraction of that proportion were even entertaining the idea. The biggest obstacle for those still undecided about central limit order books is not the oft-cited fear that anonymously displaying intentions on open-to-all marketplaces might move prices against them. Only one-third of respondents fear that. Rather, over half of investors have the more prosaic worry that the other side of the trade simply won’t be there when they want to deal.

There’s an answer to that. The more investors engage with all-to-all platforms, the better the chance that an investor taking the opposite view will appear.

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