The corporate bond market is unsuitable for full electronic trading, according to a study by McKinsey & Co. and Greenwich Associates, even as Goldman Sachs Group Inc. (GS) and BlackRock Inc. (BLK) expand their own systems.
The bond market has more securities compared with listed stocks and its issues trade at a lower frequency, making a full transition to computer-based buying and selling unlikely, the consultants said in a joint survey released today. Asset managers are “cautiously optimistic” that electronic auction systems for trading bonds will grow, the report said.
“While e-trading will undoubtedly play an important role in the future of corporate bond trading, structural realities stand in the way of attaining the order-driven ‘nirvana’ that the cash equities market has achieved,” the report said. “Corporate bond markets in the aggregate are unsuited to e-trading, and the market participants surveyed and interviewed are dubious about the prospects for bona fide match-based e-trading.”
Firms from BlackRock to Goldman Sachs have sought to build up electronic trading systems as Wall Street dealers that traditionally acted as middlemen by warehousing bonds cut the amount of debt they hold amid tighter rules on capital and risk-taking. BlackRock, which managed $3.86 trillion in assets as of June 30, said in April it instead would route trades through MarketAxess Holdings Inc. (MKTX)’s electronic system.
The consultants surveyed 117 portfolio managers, traders and analysts at investment firms in the U.S. and Europe for the survey, and conducted interviews with eight of the 10 largest dealers as well as representatives of electronic trading systems. About 70 percent of U.S. respondents expect electronic auctions to buy or sell bonds, known as request-for-quote systems, will be the method of electronic trading that proliferates in the next five years. In Europe, 85 percent said the same, the report said.
Goldman Sachs spent a year developing an electronic trading system for corporate bonds called GSessions that started operating in 2012. Other electronic trading systems for fixed income include Tradeweb Markets LLC and Bloomberg LP, the parent company of Bloomberg News, which also provides news and information to the financial community.
Almost a quarter of survey respondents believe crossing systems such as BlackRock’s Aladdin Trading Network will “play a meaningful role in the future,” according to the report. Exchange trading for bonds, where debt is bought or sold with the click of a mouse, is even less probable, with 3 percent of U.S. investors and 10 percent in Europe saying they were enthusiastic about this method, the report said.
“Fewer than 15 percent of respondents say they are willing to provide firm quotes on such systems, making it difficult to attract liquidity,” the report said.
The ability for investors to find the bonds they wanted to buy or sell was “not as bad as many had feared” in the 18 months before mid-spring of this year, according to the report. “Around 30 percent of survey respondents said that liquidity had actually improved during the prior 18 months,” the report said.
The effect of regulations related to the capital levels banks must maintain and other restrictions will make it harder to find debt to trade, according to 80 percent of U.S. investors surveyed and 55 percent in Europe, the report said.
The market for company debt, which generally trades over the counter, is growing less liquid as the biggest banks reduce the volume of their own money they use to facilitate credit trading. The 21 primary dealers that do business with the Federal Reserve have reduced their holdings by 76 percent since the peak in 2007 through the end of March, according to Fed data compiled by Bloomberg.
That reduction may not fully reflect the amount of corporate bonds held by dealers due to the Fed’s inclusion of non-agency mortgage backed securities in the data, the report said.
“It is safe to say that this change in net inventory did not have a direct impact on corporate bond liquidity,” the report said.
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