[ 2021-02-22 ]

Bond trading finally dragged into the digital age
London (UK) – 22 Feb 2021 – FT - Some trends
quietly fizzle out without leaving a mark. Others
implode, with everyone wondering what on earth we
were thinking — like Tamagochis or fidget
spinners. Occasionally, a halting, haphazard trend
suddenly hits a point where it starts spreading
like wildfire, and its success feels like it was
always preordained. Electronic bond trading fits
the latter category.

Fixed income markets have historically been
overwhelmingly analogue. Some corners have slowly
been dragged into the modern, digital era of
trading — the bigger, more homogenous and liquid
government bond markets especially. But, on the
whole, trading has long stayed bilateral, bespoke
and arranged by phone or Bloomberg messages.

The bond market was simply too fragmented, too
idiosyncratic — just too dang messy — to be
electronified like equities, many in the industry
felt. While there are about 41,000 stocks in the
world, there are millions of bonds, almost all of
them with unique characteristics. Many trade only
by appointment, if at all. Of the 21,175 corporate
bonds outstanding in the US in 2018, only 246 of
them traded at least once a day that year, and a
sixth did not trade at all, according to Citi.

Things started to shift dramatically after the
financial crisis. Stricter regulations forced
banks to shut down proprietary trading desks and
hamstrung their market-making desks by making big
bond inventories more costly to carry.

That spurred both banks and investment groups to
modernise their trading infrastructure. Meanwhile,
bond exchange traded funds grew quickly in
popularity, both enabling and encouraging more
algorithmic trading. Most mainstream government
bond trading is now electronic, and it started
making inroads into more traditionally bespoke
areas, such as corporate debt.

The Covid-19 pandemic could easily have
interrupted this trend. After all, times of
economic and financial strife should in theory
favour the human touch of an experienced trader.
Instead, it has supercharged the shift towards
electronic trading — and now threatens to upend
the entire bond market ecosystem far quicker than
predicted a year ago.

In practice, it remains tricky to untangle what is
truly a purely “electronic” bond trade from
one that is logged digitally but still arranged,
primarily, in a more traditional way by traders
gabbing on the phone or on their Bloomberg
terminals. Yet the volume data from the two
dominant electronic fixed income trading platforms
underscore how rapidly things are changing.

Average daily corporate bond trading volumes on
MarketAxess climbed 29 per cent to more than $10bn
last year, and has now almost doubled since 2017.
Tradeweb’s average daily credit trading volumes
have trebled over the same period to a record
$7.6bn in 2020.

Nor was this a brief Covid-triggered burst.
Electronic trading accounted for a record 38 per
cent and 26 per cent of overall US investment
grade and junk bond trading respectively in
December, according to Greenwich Associates. And
both MarketAxess and Tradeweb reported fresh
records in January.

Further inroads now look inevitable. JPMorgan
recently surveyed its asset management clients,
and they predicted that 40 per cent of all their
corporate bond trading will be electronic by 2022.
Almost half of all government bond trading is
already electronic, and is expected to jump to
two-thirds by 2022.

There are limits to how far this can go. The
differences between bonds and common stock are
real. No matter how good the technology, those
differences cannot be entirely erased. Nor is
going electronic likely to make the bond market as
a whole much more easily tradeable. The most
likely outcome is a migration of liquidity, rather
than an across-the-board enhancement of it.

Think of the bond market as a strip of nightclubs,
where the popular hotspots can afford to invest in
cutting-edge sound systems and laser shows. This
may attract some new punters to the neighbourhood
but dooms the less-fashionable ones to atrophy.

In other words, liquidity begets liquidity. As the
most actively-traded corners of the fixed income
market become increasingly electronified and
easier to transact in, investors will naturally
gravitate towards them, likely leaving a long tail
of poorly, rarely or never-traded debt to
languish.

Nonetheless, the longer-term implications are
legion. Setting aside what it means for the career
prospects of grizzled bond traders and salespeople
who still think Python is a snake, the dawning of
a more digital fixed income era raises a host of
opportunities and challenges for investors, banks,
borrowers and policymakers alike.

Source - FT, UK

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