US Corporate Bond Trading in 2017: This Time It Really Is Different
Smart people have been chipping away at the problem of overhauling the structure of the US corporate bond market for more than 20 years, but the dream has always been out of reach. But today, we are finally at a point where we can confidently say that ‘this time it really is different.’ We are at the tipping point where technology and interconnectivity are finally winning the battle against fragmentation, says MTS Markets’ David Parker. The market now has the ability to observe, collect and efficiently manage an amount of data representing the majority of the market, and it can do innovative things with that data.
Smart people with smart money have been chipping away at the problem of overhauling the structure of the US corporate bond market for more than 20 years, but the dream has always been out of reach.
Since the financial crisis in particular there have been billions of dollars spent, millions of words written, and thousands of jobs created by the promise of more electronic trading in the less liquid parts of the bond markets. Despite it all, the corporate bond markets remain frustratingly low-tech compared to most other asset classes.
The problem has always been rooted in fragmentation. At any given time during the trading day there are more than 20,000 bonds and close to 100 dealers providing prices. On top of that sit a number of electronic platforms, many of which are relatively new to the space. To a trader, the end result is millions of data points per day flashing in front of their eyes, most of which are of dubious quality.
Bringing change to a structure like this is a huge challenge, and one at which numerous firms have tried their hands. Failed attempts have often added value to the collective consciousness, teaching us what might or might not work; but today’s market structure looks almost exactly like it did 10 years ago.
But today, at the end of 2017 and looking ahead into 2018, I believe we are finally at a point where we can confidently say that “this time it really is different.” We are at the tipping point where technology and interconnectivity are finally winning the battle against fragmentation.
Only now does the market have access to the data and technology it needs to finally evolve. More specifically, the market now has the ability to observe, collect and efficiently manage an amount of data representing the majority of the market, and it can do innovative things with that data. And with open access and all-to-all trading, we now have a level playing field for participants to make money using that market information.
Two specific examples of this dynamic are ETFs and algos. Credit ETFs have revolutionized retail and institutional investing in corporate bond risk, and their formation and valuation have had a massive impact on the markets for their underlying bonds over the past few years.
This opportunity for disruption exists because of technology – technology which has reached the point where it can observe our fragmented market and pull enough relevant information together to let people confidently create, value, and trade hundreds of billions worth of ETFs with corporate bonds underlying.
These ETFs have had a massive impact on our markets, an influence which continues to grow. They have drawn huge retail investment into bonds and had a material positive impact on liquidity in the bonds underlying the reference indices. They have also put pressure on active managers’ fees and costs, which in a circular way is leading the active managers to embrace technology as a cost reducer and force multiplier.
Looking at algorithms, only by quickly processing millions of pieces of good data can a firm feel comfortable building an algo to trade the majority of its client inquiries. A number of banks are now rolling those out – and in doing so are revolutionizing the role of the sell-side credit trader. Last year, a client who had small-sized trades to execute would contact a dealer, which would check the markets, look at its inventory and respond with a price, whether by voice or RFQ. Next year, the vast majority of these inquiries at many dealers will be replied to algorithmically, instantly.
Market-making algorithms are also emerging on the buy side, with bigger scale than was possible a year ago. Like never before, an investor can have visibility into the entire market at one time, and can act on that information by being a price maker. The technology exists, price streaming is more prevalent, and dealer risk-taking is more limited, making the market transparent to those who don’t control the flow by trading bilaterally with clients.
With open trading and all-to-all models, non-dealer liquidity has become a major factor on electronic platforms, and flow is leading to more flow, which is leading to more innovation. By connecting to one all-to-all venue like MTS BondsPro, an alternative liquidity provider can show its pricing and trade with 1,000 other counterparties from all corners of the market.
In short, profit motives are finally combining with new technology, cross-connectivity and open protocols to make this year and next the most revolutionary we will have ever seen in terms of corporate bond market structure.
Against this backdrop, electronic market infrastructure providers have a crucial role to play in how and when this market continues to develop. Companies such as MTS have an obligation to focus on the long-term and encourage innovation and electronification by helping reduce market fragmentation, not add to it.
For our part at MTS, we pioneered the all-to-all model on our MTS BondsPro platform as a way of boosting liquidity, by enabling all participants to act as either price providers or price takers. We don’t charge the liquidity providers, because they’re benefiting the market by providing liquidity. We’re connected to nearly 100 different APIs and OMSs, and we were the first venue to connect to Bloomberg’s TSOX. In order to facilitate cross-border liquidity we now offer live trading 22 hours a day, bridging markets across Asia, Europe and the US.
We encourage our peers to do their part in making corporate bonds cheaper and easier to trade, to lower the costs to connect to venues worldwide, and to lower the barriers to entry for new types of bond traders and investors.
Together we must support innovation while fighting fragmentation. This time it really is different, but there is still a great deal of potential left to be realized. The more that providers of market infrastructure are willing to work together to serve client needs, the faster that electronic trading in corporate bonds will progress.
This article first appeared on TABB Forum. You can read the original here.