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In mid May, with the sell-off in 10-year Bunds still unfolding, a trader told Euromoney his biggest worry is not sudden losses from the sell-off but the lack of liquidity it has revealed even in bond markets that had seemed immune from that problem.
“What most alarms us inside the market is that this has been price gapping,” the trader said. “You don’t expect that kind of discontinuity in benchmark government bonds.”
Jim Reid, head of global fundamental credit strategy at Deutsche Bank, notes that this episode is just the latest to reveal the frailty of market structure.
“Those of us in the credit market saw this close up with high yield in the second half of last year,” he says. “However, that this is increasingly spreading up the top of the capital structure is a worry.
“It’s also a worry that these events are occurring in relatively upbeat markets. I can't help thinking that, when the next downturn hits, the lack of liquidity in various markets is going to be chaotic. These increasingly regular liquidity issues we’re seeing might be a mild dress rehearsal.”
Worries about the inability to turn positions round when the big sell-off starts is now hard-wired into investors’ minds.
Fixed Income Investors Survey Between February and April, Euromoney surveyed thousands of bond investors – including asset managers, banks, insurance companies and hedge funds – asking them to nominate their favoured sell-side providers of credit research and the best bond issuers.
In the course of that survey, we also asked about their concerns around secondary liquidity and what solutions they might see to improve it.
In total, 1,924 investors responded to the survey. Asked how concerned they now are about the lack of liquidity and potential inability to turn round large positions without moving the market price, an eye-catching 80% of the sample said they were either reasonably concerned (44%) or very concerned (36%).
How concerned are bond investors about a fall in bond market liquidity, and the potential difficulty in turning round large positions without negatively impacting market price? |
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Source: Euromoney Research Group Fixed Income Investors Survey, incorporating Best Borrowers and Fixed Income Research |
Two-thirds of these investors expect the situation to get even worse, with new pre- and post-trade transparency rules leaving 45% of them reasonably concerned and 17% very concerned that these regulations will further reduce liquidity.
How concerned are bond investors that regulatory changes to enhance pre- and post-trade transparency will further reduce bond market liquidity? |
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Source: Euromoney Research Group Fixed Income Investors Survey, incorporating Best Borrowers and Fixed Income Research |
What’s worse, the majority doesn’t think the various new bond trading systems and protocols set up to address the problem will help. While they are open-minded about using other trading protocols beyond request for quote and transacting on exchange like all-for-all platforms or via crossing networks, 63% of respondents think these innovations won’t improve matters.
Do new venues for trade execution and new trading protocols offer a potential solution to poor secondary credit bond market liquidity? |
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Source: Euromoney Research Group Fixed Income Investors Survey, incorporating Best Borrowers and Fixed Income Research |
Is there any good news out there? Asif Godall, head of traded credit for Europe at HSBC, tries to find some.
“Improved transparency has at least improved liquidity in smaller orders of $500,000 or less,” he says. “It is true that while the size of the credit market has doubled since 2007, dealer market-making inventory has fallen by 80% or more.
“That said, however, we are turning over our books with much greater intensity and velocity than before the crisis. In most cases this is many multiples of previous turnover.”
And there’s another reason to hope. Godall explains: “As credit markets have grown, distribution on many large bonds has become truly global across the US, Europe and Asia. So we have to be wary of saying that all investors will always face the same way at the same time.
“That may be true in particular geographies or among particular types of investors following the same benchmarks, or who have similar investor fund flows. But when the UK asset manager wants to buy or sell and so do all its peers, it may be that the US west coast mutual fund manager or the Taiwanese life insurer is taking an opposing view.”
He adds: “There are discreet pools of liquidity across the world – maybe on a bond issuer’s domestic exchange or its bookrunners’ single-dealer platforms or wherever. It is now the job of the sell side to work out how to aggregate those liquidity pools, to develop the links and connections to those pools and the algorithms to work orders across them. And that’s what we are doing.”
Investors might complain there are simply too many new bond-trading ventures being launched. In May, Bloomberg launched Bloomberg Bond Cross which allows buy-side and sell-side firms to cross and negotiate orders anonymously, with State Street acting as principal to either side.
TruMid went live in the US, offering an all-to-all anonymous platform encouraging users to enter the price and depth of orders, with the platform identifying the midpoint to cross for swarms of bonds identified as those of greatest interest to most market participants.
UBS renamed its UBS PIN-FI crossing platform as UBS Bond Port and unveiled a new link to the NYSE Bonds platform. Liquidnet, the global equities trading network, is set to launch a new European bond-crossing network in June.
Platform proliferation
Behind this proliferation of new platforms lies a collapse in technology costs, with systems that might have cost tens of millions of dollars to develop 10 years ago now costing in the hundreds of thousands of dollars, well within capacity of the many highly experienced bond-market veterans leaving the big banks to fund.
“There will be more fragmentation before there is consolidation,” says Godall. “Right now, we simply want to connect to all the platforms and aggregate across them. The buy side needs to see the benefits of aggregation.”
If new venues improve poor bond liquidity, which will you use? |
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Source: Euromoney Research Group Fixed Income Investors Survey, incorporating Best Borrowers and Fixed Income Research |
The buy side also needs to work out how to pay for it. In the past, the not-so-hidden secret about bond trading was that banks made more money from disguised carry, often leveraged, during the long bond bull market than they ever did from bid-offer spreads on client flow.
Now they need to find a way to charge for working customer orders rather than taking them as principal.
The head of credit sales at one large bank tells Euromoney: “The idea of a notional bid-offer spread that the buy side always wanted to minimize has collapsed. We work with clients especially on larger orders discussing strategies to execute them in advance.
“There is no fixed-fee schedule for this and there almost can’t be because liquidity changes not just from one day to the next but hour by hour, so that an order that might have seemed straightforward can be harder to work and take longer at certain times. The economics have to be negotiated transaction by transaction.”
