Battle heats up for e-trading supremacy

IFR 2026 29 March to 4 April 2014
7 min read
Christopher Whittall

If imitation is the sincerest form of flattery, equity traders can bask in the reflective glory of the revolution taking place in corporate bond markets. Barely a week goes by without a new electronic trading platform coming to market in the hope of shoehorning bonds into an equity-trading model – complete with dark pools, exchanges and everything else in between.

The stakes are high following a dramatic shift in the credit-trading landscape over the past five years, which has left mushrooming buyside funds fearful over their ability to buy and sell securities.

Banks, asset managers, exchanges, trading platforms and independent start-ups are all locking horns – and, in some cases, arms – in the race to build e-trading offerings that will allow bond investors to trade directly with one another.

“Quite simply, a lot of the capital is sitting with institutional and retail investors. We need to find venues similar to the equity market model where that capital can transact,” said Richie Prager, head of trading and liquidity strategies at BlackRock. “The buyside needs to become a price-maker, not just a price-taker.”

The winning formula has so far eluded high-profile attempts from both banks and investors, but this has not deterred a wave of startups challenging incumbent trading platforms such as Bloomberg, MarketAxess and Tradeweb.

Many are seeking to emulate the dark pools that grew in prominence over the past decade in equity markets, aiming to reverse the shrinkage in bond ticket sizes over the past five years.

“Capital is sitting with institutional and retail investors. We need to find venues similar to the equity market where that capital can transact”

Banks including HSBC and UBS continue to push forward with their own efforts. Liquidnet, the world’s largest dark pool operator in equity markets, is now turning its hand to fixed income, while the London Stock Exchange Group in its purchase of Bonds.com has thrown its hat into the ring. Then there are a raft of independent platforms formed by ex-industry people such as Bondcube and Electronifie waiting in the wings.

This spree of launches comes despite what some see as corporate debt’s inherent unsuitability to electronic trading due to the fragmented nature of the market. Citigroup, for instance, has almost 2,000 outstanding debt securities; it has only one share price.

“Think of it this way: liquidity in the equity market is a couple of feet wide and a couple of miles deep, liquidity in credit bond markets is a couple of miles wide and a couple of inches deep,” said Rupert Warmington, head of European credit at Tradeweb, which is majority owned by Thomson Reuters, which also owns IFR.

No panacea

Even firing on all cylinders, no one expects electronic to account for more than 10% of corporate bond trading, but this is still a prize worth fighting for. Uniting the industry behind any platform remains a formidable challenge, though.

On one side sit bulging buyside investors. Figures from Citigroup show mutual fund assets (including ETFs) were just shy of US$1trn in December – more than 12 times larger than the entire bond inventory held by dealers. That ratio was less than two to one back in 2007, but funds have since gorged on a glut of global debt issuance just as banks pared back trading activities to comply with heftier capital regulations.

In lockstep with this curtailment in risk-capital provision, average e-trading sizes have cratered to around US$300,000 – pitifully small beer for multi-billion dollar bond funds.

Despite now ruling the roost in terms of size, funds are still reluctant to take a leap of faith and start quoting bond prices themselves. Only a quarter of 117 investors surveyed by McKinsey and Greenwich Associates last year expressed any willingness to do so, even on an anonymous basis. The fear over being picked off once they reveal their positions still underpins most investors’ philosophy on e-trading.

“There are three preconditions for the success of an e-trading platform. It has to allow us to cross with [others on] the buyside in an environment where risk capital is scarce and their ownership structure is neutral or independent. Who has access to the data is very important,” said Stephen Grady, global head of trading at Legal & General Investment Management.

Winning formula

This wishlist helps explain why some early-mover single-entity platforms initially struggled to gain traction, including Goldman Sachs’s G-Sessions and the Aladdin Trading Network from BlackRock, which has since teamed up with MarketAxess on its offering.

Independent platforms have rushed to fill the gap in the market, catering foremost to the buyside community. Some services even entirely disintermediate dealers by getting custodian banks to act as settlement agents rather than asking banks to stand in the middle of client-to-client trades.

Most venues offer a range of trading protocols. These include the traditional request-for-quote model, streamed prices on a central limit order book, auction sessions and dark pools.

But placating the buyside without alienating the sellside is a tough line to walk. Unlike in equities, bond investors cannot just look to exchanges for a share price – banks are still at the centre of the price discovery process. This dynamic explains banks’ continued interest in running their own platforms in which they play an agency role matching up client trades, despite client concerns over ownership.

“There is very little perfect natural crossing between clients on bonds – we solve this by managing the flows algorithmically,” said Paul Hamill, who as global head of execution services for FX, rates and credit at UBS oversees the bank’s PIN e-trading platform.

“You need a critical mass of volumes on a platform to even get close to riskless trading, and clients need to see it working to establish trust in the model.”

Multilateral treaty

Nonetheless, most practitioners agree multilateral trading platforms are the future provided venues can offer a sufficiently juicy carrot to tempt banks to jump on board. This means ensuring their role involves more than quoting prices on a screen only to be cut out of the end deal. Only those that manage to strike the right chord with both sides of the industry will succeed in being more than also-rans.

“It’s a bit like the dotcom boom – some initiatives will work – but the truth is building a viable multi-dealer system is a very difficult task,” said Niall Cameron, head of credit at HSBC, which recently launched its own Credit Place e-trading venue.

“Even then, it doesn’t solve the fundamental problem. It may be a good system for peace time, but when the market is volatile, everything shuts down.”

Price reflections