Financial market structure changes, largely driven by G20 reforms, are arguably the catalyst to the inefficiency and ever increasing liquidity drought in the secondary european corporate bond markets which investors look to address. Access to liquidity remains
the biggest challenge for investors as banks are unable to provide liquidity because of the standards imposed by Basel III which prevent them from holding inventory to the levels they used in the past. Deviating interest rates are likely to increase volatility
with UK and US probably on the rise, EU/ECB and Bank of Japan likely to drop and Switzerland likely to remain negative at -0.25%; these, arguably, could result in banks not being able to hold any inventory even if they wanted to. Another aspect is the narrowing
market share concentration with tier-1 banks, whilst tier-2 market share is widening.
While regulators are keen to express their unhappiness with the lack of liquidity in the market, they are doing nothing to help. If they were that worried about liquidity they would introduce an exchange traded model, for example. Exchange traded is probably
suited well for multi-nationals with standardised maturity of 5s, 10s and 30s. It would, however not be ideal for some SMEs and those that want smoother humps of 2s, 3s, 5s and 10s. Nevertheless, it would introduce a level of standardisation that would be
welcomed, it would increase liquidity and reduce the costs for that segment of the market. Costs would likely push up for the smaller firms, so an alternative best-fit/need model would also be required for SMEs and those that don’t want the standardised maturities.
Industry driven and sponsored initiatives looking to try to resolve the liquidity drought are fragmenting the market structure further. Bank business models are shifting from principle to agency trading, while investors are exploring buy-side to buy-side
trading via new all-to-all platforms such as Liquidnet and Bondcube.
Another issue impacting liquidity in the european markets compared to the US is the level of assets the asset managers are running. Assets are spread too thinly in europe between asset manager, insurance companies, private banks and other players in the
fixed income markets. Consolidating these assets would be a step in the right direction to cure the liquidity issue.
These challenges are rapidly changing the corporate bond market structure with 30+ credit cash trading venues live/in-development, 20+ credit derivatives/SEFs live and we are likely to see the same additional increase when OTFs are introduced with MiFID
As investors look for solutions, the proliferation of venues is increasing demand for electronification and although Fixed Income markets have traded on electronic platforms for many years, the electronic evolution for corporate bonds is only just beginning.
Over 50% of corporate bond trades are voice executed compared to over 60% of government bonds electronically executed. Investor electronic increase across both markets is largely on multi-dealer platforms rather than single-dealer platforms with investors
adopting a multi-venue strategy; although this is still very much in the evaluation stage.
Undoubtedly, we are witnessing a seismic change in the corporate bond markets with the introduction of new trading venues. However, none of these alone, are likely to be the saviour to solving of the liquidity problem. For investors, one of the keys is knowing
who has the inventory they require, firm bids and offers, and then, where to trade it. To do this, they need access to pre-trade information from all venues and from the banks of which most of the new entrants are not willing to provide.