Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

Morgan Stanley is making a lot of noise about shrinking its fixed-income unit. Other Wall Street banks may spin it differently, but they are preparing for a similar debt-trading future as Morgan Stanley, one that is less lucrative and likely to stay that way. 

They are quietly cutting staff, reducing the capital they commit to riskier debt businesses and planning for an era of more electronic trading.

One significant example of this is that banks are increasingly matching buyers and sellers of riskier debt and using less of their own money to facilitate client trades as they have in the past. These types of trades now account for about 70 percent of U.S. high-yield bond volumes, up from 30 percent in 2011, according to TABB Group data.

Matching Game
Banks are increasingly matching bond buyers and sellers without putting their own money at risk.
Source: TABB Group

In other words, investors are increasingly transacting with one another, with traders simply in the middle to give price guidance and help investors negotiate anonymously. It seems as if a computerized marketplace could eventually take over, although credit traders have been relatively slow to adapt to such systems for a variety of reasons.

Morgan Stanley has emphasized that it doesn't think fixed-income revenue will ever return to its previous level. It has cut about one-quarter of its debt-trading staff, with its chief financial officer Jonathan Pruzan saying Tuesday, "That revenue pool for the industry has been shrinking, it’s continued to shrink, and we came to the conclusion that we thought the prospects for that revenue pool rebounding anytime soon was very limited.''

In the meantime, banks are laying the groundwork to more quickly adapt should there be greater momentum behind electronic credit-trading systems at some point in the future. Morgan Stanley, for example, just appointed Sam Kellie-Smith to revamp its fixed-income unit after he previously helped the New York bank become Wall Street’s top equities-trading shop by revenue.

"The banks are leading with their feet,'' said Anthony Perrotta, global head of research and consulting at TABB Group in New York. "If you pull back the emperor’s robe, they’re all preparing for'' a time of more electronic transactions in credit and more so-called riskless-principal trades, or just matching buyers and sellers.

Concentrated Trade
A greater proportion of junk-debt trading is taking place in the most-active bonds.
Source: Finra's Trace data, Bloomberg

As of now, there's a clear void to be filled. While credit traders are turning more to exchange-traded funds, which typically own the most-frequently traded bonds, they're struggling even more to conduct transactions in the less-popular corners of corporate-debt markets. Trading in the most active high-yield bonds accounted for 51 percent of overall activity in the market last year, up from 44 percent in 2014, according to Finra's Trace bond-pricing data.

The debt-trading business is undergoing a fundamental transformation. While Morgan Stanley has been the loudest to point this out, it might as well be speaking for all the big banks. Their bond-trading operations need to be more agile to adapt to a permanent shift in the landscape.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net