Technological advances. Flexible trading protocols. More transparency, but not too much more.
Those are a few of the structural improvements that will drive continued ‘electronification’ in the corporate credit market, said speakers at the Sandler O’Neill Global Exchange and Brokerage Conference.
Industry figures show that 20% to 25% of U.S. investment grade bond trading volume happens via electronic channels, about double the proportion for high yield bonds. Smaller-sized trades dominate screen-based trading, and while block traders are slowly warming up to electronic platforms, the industry has yet to figure out how to pry the phone from their hands.
Drivers of incremental progress toward that end are all-to-all trading, which enables transacting with a wider range of market participants; so-called alternative liquidity providers such as Citadel Securities, Virtu Financial and Jane Street, which have gained influence as big banks stepped back from the market; and potentially changing reporting requirements via regulation, in a way that ideally boosts activity without forcing institutions to show their cards.
There is comfort in dealing with a trusted counterparty over the phone. James Wallin, Senior Vice President, Fixed Income at AllianceBernstein, said his firm’s traders need to have confidence before putting a trade on an electronic platform. “It’s not reasonable from a client standpoint and a fiduciary standpoint to put our intentions out to the public without taking the market’s temperature.”
Wallin indicated optimism about the future of electronic trading. “We are seeing development of tools and an evolution of transparency that could, down the road, give us more confidence to go out to the market with larger trades,” he said.
Ultimately, the trajectory of electronic trading comes down to “what are ways technology can be applied to help buyers and sellers find each other in less liquid markets?” said Kevin McPartland, Head of Market Structure & Technology Research at Greenwich Associates.
One structural limitation is that there are many more corporates bonds than there are equities, and each bond trades much less frequently. A newly issued corporate bond might start out trading in block size 20 times per day, then five times per day, then essentially “by appointment” only, said Sonali Theisen, Head of Fixed Income Market Structure at Bank of America Merrill Lynch.
For electronic trading to rise meaningfully in the current market structure, “there would have to be fewer blocks and smaller ticket sizes,” Theisen said.
All-to-all trading , which Wallin described as a “quasi virtual exchange for bonds,” has made inroads. “It allows the buy side to participate in being price maker, and it deepens the pool of liquidity overall,” said Matt Berger, Global Head of Fixed Income and Commodities at Jane Street.
“It’s one more tool in the toolkit,” McPartland of Greenwich said. While all-to-all’s 6% penetration level in corporate bonds is modest, “it’s notable that it exists at all, because 10 years ago it didn’t,” he said.
It has been proposed that for purposes of regulatory reporting, the size of a block trade be increased from $5 million to $10 million in investment grade, and from $1 million to $5 million in high yield. The idea is that lifting the block size would lead to more automated trading.
The proposal is currently being debated and remains a ways from being implemented, panelists said.
With regard to electronic trading platforms, the consensus is that new entrants would be welcomed and used if they differentiate and add real value, but the buy side is discerning on this front because connecting to each platform is a pain.
“There has to be competition but also there are limits on our infrastructure,” AB’s Wallin said. “Platforms that have taken root have helped our business. We’re open to new ones that can help with specific needs, but we can’t hook up to everybody in the world, so we’re not looking forward to 40 or 50 platforms.”
