Forget Bond Dealers: Trading Among Investors May Be NormLisa Abramowicz
Credit investors probably don’t need Wall Street as much as they think they do. They just need a better way to find each other.
So far this year, about 52 percent of corporate bonds traded on a typical day started and ended the session in hands of investors, up from 47 percent in 2011, according to Financial Industry Regulatory Authority data compiled by Electronifie Inc. Those figures suggest -- if investors could bypass banks -- that the debt could often go directly from one money manager to another.
Bond dealers, which traditionally dominated trading in this over-the-counter market, are reducing the amount of their own money they use to facilitate credit trading in the face of new risk-curbing rules. They’re increasingly just acting as agents between buyers and sellers, matching up investors with one another trade by trade.
Now, firms from Electronifie, which is building an alternative credit-trading system, to MarketAxess Holdings Inc., a dominant electronic marketplace for corporate debt, are finding ways for investors to trade directly with one another.
“There is natural liquidity between customers,” said Amar Kuchinad, Electronifie’s chief executive officer and a former senior policy adviser at the U.S. Securities and Exchange Commission. “Dealers are increasingly less able to provide immediate liquidity.”
The 22 primary dealers that do business with the Federal Reserve have reduced their holdings of corporate bonds by 9.4 percent since the beginning of April 2013 to a net $16.9 billion as of Nov. 12, according to Fed data.
Of course, if Wall Street is just crossing bonds without risking its own money, regulators and investors are questioning whether it’s worth paying such high fees to them.
While dealers have been told for decades that they can’t mark up bonds more than 5 percent without regulators deeming their fees excessive, Finra considers the real ceiling for most corporate-bond trades as 3 percent or even less, people with direct knowledge of the matter said in May.
So far, the corporate-debt market has been slow to adopt more up-to-date technology. Just 16 percent of investment-grade bond trading was conducted on electronic systems this year, compared with about 48 percent of U.S. government-debt trades, according to Greenwich Associates estimates.
One reason analysts say the market is a laggard in this department is there are thousands of individual, relatively illiquid bonds. Electronifie’s Kuchinad argues this isn’t as big an impediment as traders say because the bonds that are changing hands at any given time are a small subset of the overall universe.
About 75 percent of trading took place in 8 percent of outstanding corporate securities in the three months ended Sept. 30, according to data compiled by Electronifie.
Investors are complaining that the retrenchment of bond dealers is making it harder to trade. The biggest money managers, including BlackRock Inc., are pushing to accelerate the use of electronic marketplaces for debt that’s often traded in phone calls.
If bond dealers are more and more just crossing bonds from one investor to another, money managers may find it easier to replace them with computer software.