bond trader phone Copyright Scott Olson, Getty Images

Middlemen the Key to Corporate Bond Market's Electric Dreams

E-trading platforms cut costs and add liquidity by unlocking bond inventories not otherwise available.

Goldman Sachs, the biggest standalone U.S. investment bank, shuttered its GSessions electronic bond-trading platform in 2014. BlackRock, the world's biggest asset manager, closed its Aladdin bond trading network after less than a year in 2013. Last spring, Deutsche Boerse, owner of the Frankfurt Stock Exchange, pulled its funding for a platform called Bondcube.

Bloomberg LP, Thomson Reuters, parent of Reuters News, and about 30 other companies operate corporate bond e-trading businesses, most of which have struggled to gain traction with users. In an era when stocks are almost exclusively traded electronically, commodity trading pits have closed and currency traders increasingly conduct their business on computers, corporate bond trading is primarily done by people over the telephone.

"There is something beneficial from trusting the person, and the way that you phrase something and the way that they phrase something over the phone – it's an old fashioned skill but it is a skill," said Paul Squires, head of trading at AXA Investment Managers in London, one of Europe's largest fund firms, with more than 690 billion euros ($741 billion) of assets under management.

"It is a relationship thing that is unlikely to ever disappear, however many hubs and platforms crop up."

Paul Reynolds, former CEO of Bondcube, is trying again with his latest venture, Bondchain, a messaging service that connects asset managers who want to buy and sell company debt with their brokers.

"It doesn't bypass that relationship, it enhances it," said Reynolds, who is in talks with potential partners for Bondchain and is aiming to launch it in the first half of next year.

"What they need, and I think this is unique to fixed income, is someone in the middle to nurse them into a transaction."

The relationship between bank dealers and investors has persisted despite post-financial crisis curbs on banks' ability to buy and sell corporate debt that make it more expensive and time-consuming for fund managers to trade.

And even amid warnings of a liquidity crisis should a market shock spook investors and force them to sell en masse, fund managers are wary of hanging up the phone to their broker-dealer and moving entirely to electronic platforms.

The big banks control new bond issuance and the more an investor trades with a bank, the better the chance they have of getting a big allocation of new bond sales, which typically offer higher yields and larger sizes than those available in the secondary market.

"Having access to the allocation of new bond issues is one of the best ways for investors to source liquidity," said Zack Ellison, a U.S. fixed-income trader at Sun Life Investment Management.

Critical Mass

E-trading platforms say they can cut costs and add liquidity to the market by connecting investors and unlocking bond inventories that would not otherwise be available.

"It's been the realm of the big bulge brackets and they've made so much money that they've crowded everybody else out of the market," said Seth Merrin, chief executive officer of brokerage Liquidnet.

His firm has opened a "dark pool" for corporate debt, where investors can post their available bonds without others seeing them unless they have the opposite side of the trade and the two sides are matched.

Liquidnet runs one of more than 30 corporate bond e-trading platforms, with 23 having been started since 2010, according to financial consultancy GreySpark.

MarketAxess (MKTX.O), which lets firms request quotes from several dealers at a time, allowing them to maintain their relationship with bank traders, has gained the biggest share of corporate bond e-trading volume – about 17 percent of U.S. high grade bond trades in the third quarter, according to Trace, the reporting system set up by the Financial Industry Regulatory Authority.

MarketAxess's momentum has boosted its stock, which is up almost 60 percent over the last 12 months compared with 4 percent for the S&P 500, pushing its market cap up from $500 million in 2010 to $3.8 billion.

Competitors include Tradeweb, majority-owned by Reuters News parent Thomson Reuters (TRI.N), as well as Bloomberg ETOMS, Electronifie, and TruMid.

The key to success is to get a critical mass of support. Several, including Goldman's (GS.N) GSessions and BlackRock's Aladdin bond-trading network, have come and gone as investors sit on their hands amid a glut of new offerings. Deutsche Boerse said it took a 3.9 million-euro loss on Bondcube in the second quarter and a loss of as much as 700,000 euros in the third quarter.

Platforms that have tried to bypass the broker-dealers and connect buyers and sellers directly have so far struggled to catch on, partly because of concerns over how confidential information would be handled.

"The only electronic platforms that have succeeded are those with a dealer on the other side who is willing to commit capital and facilitate the transaction," said Rick Rezek, a senior portfolio manager at Schroders. "I wouldn't want to put something on a platform at BlackRock and let them see what I am doing, and they wouldn't do that either."

Higher Costs

About 20 percent of investor grade corporate bond trading occurs electronically and most of that happens only in liquid names and smaller trade sizes, according to MarketAxess.

Of the 50,000 corporate bonds outstanding last year, around 30,000 traded at least once in the secondary market, while just 1.1 percent of those traded every day, and 27 percent traded at least once a month, according to MarketAxess.

The reliance on voice trading in company debt has meant ordinary investors ultimately pay more. Corporate bond market transaction costs for the year-ended March 31 were at least $26 billion, several times higher than for similar-sized trades in the stock market, said Lawrence Harris, a professor at the USC Marshall School of Business, in a recent paper.

Kathleen Gaffney, manager of the $1.4 billion Eaton Vance Bond Fund, said it can take weeks to execute a trade worth $20 million and she often has to pay a "liquidity premium."

"You really have to like what you own and stick with it."

 

(Additional reporting by Olivia Oran, David Henry and Richard Leong in New York. Editing by Carmel Crimmins and John Pickering)

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