Bondcube Failure Reveals Pricing Flaw in $8 Trillion Bond Market

The collapse of fixed-income trading platform Bondcube after only three months highlighted an obstacle to creating new trading venues in the $8 trillion market: a lack of prices to foster liquidity.

Corporate bonds change hands privately over the phone or instant message or on a handful of electronic venues. Although completed transactions are reported with a 15-minute delay, that represents only a sliver of the market. Many bonds don’t trade for weeks or months, leaving gaps in pricing that historically were filled by banks that had more market information at their command than their customers.

On Bondcube, which announced its closure on July 22, investors who found each other on the company’s system often couldn’t agree on a price, according to a person familiar with the matter, who asked not to be identified because the information isn’t public. So bids and offers were too far apart.

“The price discovery element is quite critical,” said Will Rhode, global head of capital markets research at the Boston Consulting Group. “With little data in a bilateral negotiation with two different viewpoints, it’s hard to get something done.”

U.S. government officials recently recommended expanding price reporting for Treasury bonds. Yet only about 13 percent of the 50,000 outstanding U.S. corporate bonds trade in a given day, according to the Financial Industry Regulatory Authority, which maintains the Trace price-reporting service. That leaves a huge part of the market without reliable prices for new bond shops to reference.

Crisis Aftermath

Bondcube competed with MarketAxess Holdings Inc., TruMid Financial LLC and Electronifie Inc., which operate their own electronic venues that are trying to help make it easier to trade U.S. corporate debt. Regulations following the 2008 financial crisis reshaped the business by limiting the risk banks can take and making it more expensive to hold bonds in anticipation of customer demand. Both changes have made it more difficult for investors to buy and sell debt.

Paul Reynolds, chief executive officer of Bondcube, declined to comment.

Bondcube was designed as a dark pool for debt, where banks or investors could leave indications of interest for the exact bonds they were looking to buy or sell. When an order matching the resting order came in, both sides were notified. That’s where the lack of reliable pricing hurt the venture, because there often were no independent marks to use for negotiating.

That contrasts with markets like U.S. stocks, where there are central price feeds -- called securities information processors, or SIPs -- that publicly broadcast the prices for shares. Although trading on equity dark pools is secretive, users of those platforms can rely on the SIPs as a guide to prices, and even decide to strike a deal at the midpoint between the current national best bid and offer prices.

Not Familiar

“I’ve seen a number of the bond platforms introduce some of the indicative pricing to try to start negotiations between two institutional accounts that aren’t necessarily familiar or comfortable being price makers,” said Mike Adams, an analyst with Sandler O’Neill & Partners LP in New York.

“The bigger thing really is behavioral change within the buyside trading community. They’re trying to adjust,” he said. “They are hiring more guys with sellside broker-dealer experience, guys that are more comfortable or with experience being market makers, trying to play a similar role now on the buyside. That’s going to take some time.”

Prices in U.S. corporate debt are reported to Trace after a 15-minute delay. The bond market, however, is made up of hundreds of thousands of unique issues, many of which don’t trade every day or even every week, leaving large gaps in the pricing service.

Targeting Treasuries

Transparency isn’t just an issue in the corporate bond market. Earlier this month, a joint report by several U.S. regulators recommended expanding public reporting of Treasury bond trading. Investment managers trade Treasuries through Wall Street banks known as dealers, both over the phone and electronically. Unlike in corporate debt and equity markets, trades done directly between dealers and clients aren’t reported publicly.

U.S. authorities will study whether Wall Street should expand disclosure of Treasuries trading, according to the report.

Bloomberg LP, the parent of this news organization, also has a platform for trading corporate bonds. London-based Bondcube was 30 percent owned by Deutsche Boerse AG, which provided two rounds of investment. It went live for fixed-income trading in the U.S. and Europe in April.

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