Bond Traders Vanishing as Liquidity Evaporates

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Bond traders are vanishing as slumping fixed-income revenues deter the world’s biggest banks from making markets in Europe.

The average number of dealers providing prices for European corporate bonds dropped to a low of 3.2 per trade last month, down from 8.8 in 2009, according to data compiled by Morgan Stanley. The three largest U.S. banks -- JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc. -- posted their worst combined quarterly trading revenue since 2011 in the fourth quarter, led by a 23 percent drop in fixed-income, currencies and commodities.

The decline in trading is making it harder for investors to buy and sell company securities, raising concern that it will be difficult to get in and out of positions in times of market stress. Regulations introduced since the financial crisis, and meant to reduce risk-taking, are eroding the financial rewards of trading and prompting banks to reduce their inventories of securities.

“The liquidity of the bond market has changed fundamentally in the last five years and it is the issue we are most concerned about,” said Jon Mawby, a London-based fund manager at GLG Partners LP, which manages $32 billion. “Banks are less willing to take on risk, which means that we have to think about what we can we do to mitigate the liquidity risk their reduced balance sheet capacity introduces.”

Earnings Slump

Trading in European corporate bonds has fallen about 70 percent since 2008, according to Royal Bank of Scotland Group Plc. In the U.S., while the size of the investment-grade market expanded 90 percent in the five years since 2009, average daily trading has only climbed 10 percent during the period, according to data compiled by Bank of America and the Financial Industry Regulatory Authority.

European lenders including HSBC Holdings Plc and Credit Agricole SA will start reporting earnings later this month, according to data on their websites. Credit Suisse Group AG said on Thursday revenue from fixed-income trading slumped 18 percent to 610 million francs ($656 million) in the fourth quarter.

Deutsche Bank AG, which saw its revenue from trading debt and currencies rise 13 percent in the fourth quarter from a year before, is identifying individual trading businesses to exit as part of a review of the profitability and capital requirements of its investment bank. The company said in November it would cease trading most credit-default swaps tied to individual company debt as capital regulations make it more costly to operate in that market.

‘Elusive’ Profits

“Profitability from trading bonds is elusive,” said Gianluca Minieri, Dublin-based global head of trading at Pioneer Investment Management, which oversees $244 billion. “Traders are only willing to buy and sell when the overall cost of capital of that trade makes sense and this reduces the level of trading volumes in the market.”

Reduced trading of corporate bonds should not be a big concern for investors because they should buy the notes and hold them to maturity, rather than trying to get out at the at the first signs of market stress, said Brian Scott-Quinn, the non-executive chairman of the ICMA Centre at Henley Business School.

“Bonds are designed to be buy-to-hold, the idea you should have a lot of liquidity is nonsense,” said Scott-Quinn. “One problem we have with the system is not enough capital is patient capital willing to sit out the ups and downs in the market, but instead pays a price for instant liquidity.”

Capital Costs

Euro-denominated corporate bonds got an average of 3.4 dealer quotes per trade last week, up from 3.2 recorded in January, the lowest in Morgan Stanley data that goes back to August 2009 and is based on dealer prices compiled by Markit Group Ltd. for bonds in its iBoxx indexes. Quotes for bonds in pounds fell to a record low of 3.6 last week from a peak of about seven in 2011, the data show.

Banks, which once dominated Europe’s bond market by providing large warehouses of fixed-income securities to meet client requests, are now acting as middle men to connect buyers and sellers rather than taking on any risk themselves. New regulations since the financial crisis, including the Volcker rule in the U.S. and Basel III in Europe, have required banks to raise capital to offset holdings of securities on their balance sheets.

The increase in capital is incentivizing lenders to replace lost trading income with fees from less capital-intensive activities, such as arranging new bond deals, said Pioneer Investment’s Minieri.

“Traditionally the debt capital markets business involved origination, syndication, trading, sales and research, but this is in flux as banks focus on their balance sheets,” said Brett Chappell, Copenhagen-based head of fixed income trading at Nordea Investment Management, which oversees 174 billion euros. “The return on equity per employee is under the loupe.”