More than 50% of top U.S. Treasury dealers have stopped actively making markets on interdealer platforms—a dramatic change to a market in which virtually all leading dealers once performed this function.
Stepping in to fill the void are principal trading, non-bank entities that are making markets both within the major trading venues and via bilateral relationships. .
“These changes are part of an ongoing evolution of market structure in which new business models and trading mechanisms are blurring the lines between liquidity makers and liquidity takers,” says Kevin McPartland, Head of Market Structure and Technology Research at Greenwich Associates and author of a new report, U.S. Treasury Trading: The Intersection of Liquidity Makers and Takers.
To better understand how changes in technology, regulation, business models, and market practice are altering the structure of the U.S. Treasury market since the “Flash Crash of 2014”, Greenwich Associates interviewed 103 U.S. institutional investors active in U.S. Treasuries, 13 dealers that collectively handle nearly 80% of all client trading in U.S. Treasuries, and six of the highest volume principal trading firms in the U.S. Treasury market.
Alternative Liquidity Providers
Greenwich Associates research shows the top five dealers in U.S. Treasuries now handle 60% of investor trading volume—up from just 44% in 2005. However, of the top 10 firms by trading volume on major inter-dealer platforms like ICAP’s BrokerTec and Nasdaq’s eSpeed, only two are primary dealers of U.S. Treasuries. The balance is made of non-bank liquidity providers, primarily firms committed to making markets such as KCG and Virtu, recently dubbed by the Joint Staff Report on October 15, 2014 as “principal trading firms (PTFs)” for their role in providing incremental liquidity.
Twelve percent of investors say they are either already trading with non-bank liquidity providers or plan to in the coming months. Given that a considerable amount of PTF trading in the U.S. Treasury market is done on anonymous platforms, the number of investors interacting with their liquidity is likely even higher than that.
New Business Models and Trading Mechanisms
The study results show the market structure is being altered by new technology that enables new business models and trading mechanisms. Overall, about one-in-five of the liquidity providers participating in the research study, including four top 20 banks, provide direct streams not only to customers, but to other dealers.
Along those lines, some dealers are also starting to work with, rather than against, market makers. Greenwich Associates research found that 35% of the top 20 dealers now consume at least one PTF direct-pricing stream and execute roughly 25% of their traditionally interdealer flow through those channels.
At the same time, a handful of investors in the study have started trading on what were previously dealer-only platforms. This trend toward investors trading on anonymous all-to-all platforms appears set to continue, with one in five investors telling us they either have or plan to gain access in the coming years.
“Although the largest U.S. Treasury dealers will remain a central part of this market due to the expertise and balance sheet they provide clients, their role—and the traditional market structure as a whole—is changing as technology erodes distinctions between competitors, partners and customers,” says Kevin McPartland.
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