Humans Beat Machines as Electronic Trading Slows: Credit MarketsLisa Abramowicz
Machines that are replacing humans in much of the fixed-income market are proving less successful in one corner of Wall Street: credit trading.
A shift in corporate-bond transactions to electronic systems is failing to keep up with total volume, accounting for 19 percent of investment-grade trades worldwide last year after reaching 20 percent in 2012, according to a Greenwich Associates survey of institutional money managers. That contrasts with government-debt markets, where 49 percent of U.S. trades were done electronically last year after 31 percent in 2012.
The slowdown in electronic exchanges of company debt is helping to ratify efforts by dealers from Royal Bank of Canada to Royal Bank of Scotland Group Plc to hire more traders that profit from matching buyers and sellers over the telephone. While the world’s biggest banks have been shrinking teams of government-debt and currencies traders as more of those transactions go electronic, they’re finding that the thousands of debentures governing corporate securities aren’t as easily commoditized.
“The prevailing view is that there is a huge growth opportunity in corporate-bond electronic trading, but that doesn’t seem to be the case,” said Kevin McPartland, head of market-structure research at Greenwich Associates, a Stamford, Connecticut-based financial research firm. “The current market structure is not particularly suited to levels of electronic trading seen in other markets.”
While total electronic investment-grade bond transactions increased, they lagged behind growth in all trades, according to the firm’s survey of investors who generally trade in chunks of $250,000 or more. The data, which will be published today, doesn’t include individual buyers, who typically trade in smaller sizes that are more conducive to automation.
The proportion of investment-grade bonds that traded electronically in the U.S. fell to 8 percent last year from 14 percent in 2012, Greenwich Associates data show. In Europe, buyers boosted electronic trades to 31 percent of all investment-grade activity in the region, from 29 percent the prior year.
“The problem is that corporate debt trades by appointment,” said Brad Hintz, a New York-based analyst at Sanford C. Bernstein & Co. “Much of the market doesn’t turn over fast enough to allow an electronic netting system to be useful.”
While bond investors rely on dealers to be on the other side of a majority of their trades “the Street can’t be there anymore” because of stricter capital rules, he said.
The tepid adoption underscores the concern that the market’s infrastructure will be unable to withstand a significant deterioration in investor sentiment, amplifying losses for bondholders. Dollar-denominated, investment-grade bonds lost 1.5 percent last year, the first annual decline since 2008, as speculation mounted that the Federal Reserve would slow the pace of its monthly debt purchases.
Wall Street’s biggest banks are committing less of their own money to facilitate trades as they comply with rules issued in 2010 by the Basel Committee on Banking Supervision and the Dodd-Frank Act passed by Congress the same year. That’s leading investors to trade more frequently and in smaller sizes.
Trading is failing to keep pace with a corporate-debt market that’s expanded by 56 percent since 2008 after central banks globally pumped trillions of dollars into the economy to boost growth. The stimulus is fueling so much demand for higher-yielding debt that bondholders have been reluctant to part with it, said Brad Golding, a managing director at Christofferson Robb, a New York-based asset manager.
“When the market re-normalizes from an interest-rate and spread point of view, you get more two-way” trading, he said. “Quantitative easing is keeping these markets from functioning properly.”
Corporate bonds, which traditionally trade over the phone, are more difficult to standardize than currencies and Treasuries because a single company may have many securities outstanding that are all governed by different contracts. Investors traded 28 Ford Motor Co. bonds during the past five days, each with unique coupons and maturities, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Bloomberg LP, the parent company of Bloomberg News, competes with MarketAxess Holdings Inc. and Tradeweb Markets LLC in facilitating bond trades between investors and banks, and in providing financial data to investors.
MarketAxess’s electronic platform captures the greatest share of investment-grade bond trading in the U.S., while Bloomberg leads in Europe and Asia, according to the Greenwich Associates survey. Tradeweb’s system has the largest share of government-bond trading in the U.S. and Europe, Greenwich said.
The biggest banks have helped fuel a move to automated platforms for government debt as they seek to reduce exposure to Treasuries, which lost 3.35 percent last year as yields rose from all-time lows, according to Bank of America Merrill Lynch index data.
In January, Barclays Plc’s European head of foreign-exchange sales and head of hedge-fund rates sales in the region left as the lender cut back its fixed-income, currencies and commodities operation, people with knowledge of the matter said at the time. Credit Suisse Group AG cut about 50 jobs in New York and 65 positions in London within its fixed-income department, people with knowledge of those moves said in November.
By contrast, Toronto-based RBC expanded its U.S. credit team with about 20 hires in the two years through November. RBS added five senior members to its Stamford-based junk-debt trading and sales unit since July.
Corporate-bond investors need liquidity, said Greenwich Associates’ McPartland. “But the market structure hasn’t changed to allow electronic platforms to make it easier to find liquidity.”