In late January, MarketAxess launched its all-to-all Open Trading platform in European credit. This enables bond buyers and sellers to source liquidity from all other system participants in a single market place and brings MarketAxess’s alliance with BlackRock’s groundbreaking Aladdin community, which crosses trades between asset managers, to Europe.
Rick McVey, chairman and chief executive of MarketAxess, pointedly linked the potential of all-to-all trading to improve bond market liquidity to recent heightened volatility and rising investor fears over price gapping. McVey notes that over 7% of US high-grade trades on MarketAxess now take place via Open Trading protocols, compared to just 2% a year ago, an acceleration of take-up that has coincided with rising volatility.
At the end of last year the Bank for International Settlements acknowledged that trading is increasingly concentrated in just a few liquid issues in most corporate bond markets.
In the US, for example, the share of corporate bonds with a 12-month turnover ratio of at least 50% (i.e. the sum of traded volumes accounting for at least half of the securities’ outstanding amount) had declined from 20% in 2007 to less than 5% six years later.
And when Worldwide Business Research surveyed 90 European fixed income investors last year, it found that sourcing liquidity was the biggest challenge for 73% of them and that 43% intended to do more trading with other participants on the buy-side in an attempt to overcome this.
A move away from the old request-for-quote model of the over-the-counter bond markets to something that smacks more of order books and transparency might make regulators feel they are doing a good job.
It would probably be a mistake for regulators to pat themselves on the back, however.
Ultimately, bond investors’ response to constricted liquidity may be to make the market darker, not more lit. New trading protocols are not in themselves the answer. The key for investors is sourcing better information to identify the other side of the trade without information leaking on their intentions and moving prices against them. In thin markets rendered less stable by regulatory change, small volumes can have a big effect on price.
Bondcube, for example, sees this. It allows users to submit enquiries to each other without market risk in the form of Indications of Interest (IoI) that are matched darkly. Also last month, MTS, one of Europe’s premier fixed income trading venues, launched an initiative with B2Scan, an aggregator and search engine of bank inventory, runs and axes for the buy-side, which enhances pre-trade information. MTS looks largely wedded to the request-for-quote trading protocol. It’s interesting to see it promote an alliance with a small provider of what could turn to be highly valued premium content for investors.
|Here comes the great bond|
The real revolutionary in all this could be Algomi, which is rapidly signing investors up to its Honeycomb system. This asks banks to permit selected investors to set up encrypted areas inside the banks’ own trading systems from which these investors can watch, unbeknownst to the bank, for signs of activity in certain bonds they want to trade before dealing directly with the bank showing the highest recent trading activity, current axes or portfolio knowledge.
Honeycomb is gaining ground fast. It’s all about darkening the market, helping investors reduce all information leakage on big trades and then working them through a single dealer. It seems almost the opposite of what regulators want and raises questions of how that squares with the push to pre- and post-trade transparency and compliance with best execution rules.
Is there any alternative, though? The trend seems to be in one direction. Bond markets have got big. Intermediating capital available to smooth market adjustments has got small.
Investors could just give up any pretence that credit securities are liquid. They’d have to find a new name though. They probably couldn’t call them bond funds anymore: maybe loan funds would be more accurate.