Electronic Bond Trading May Sap Liquidity Amid Stress, BIS Saysby
About 70% U.S. Treasuries market is traded electronically
More data needed to assess impact of automation on bond market
The growth of electronic bond-trading may reduce liquidity during times of market stress, according to the Bank for International Settlements.
“While there has been an improvement in certain metrics, liquidity may have become more fragile during stress episodes,” the BIS said in a report on Thursday about the shift from telephone trading to centralized, electronic markets. “More sophisticated measures need to be used to capture the multiple dimensions of market quality.”
The report adds to concerns about liquidity in debt markets, as tighter capital regulations deter dealers from holding bonds to facilitate transactions. It also focused on high-frequency trading, which has split opinion between advocates saying it cuts costs and detractors who see it as a way for traders to profit at the expense of investors.
There aren’t yet enough studies to determine whether high-frequency trading benefits bond markets because of a lack of data, said BIS, whose members include 60 central banks. A key issue is whether there is enough benefit to justify the expense of improving trading performance by a few milliseconds, it said.
U.S. Treasury trading is about 70 percent electronic, compared with less than 60 percent in 2012, the report said. Electronic trading of European government debt has risen to 60 percent from less than 50 percent.
Electronic trading also now accounts for more than 20 percent of transactions in high-yield bonds and 40 percent of dealing in single-name credit-default swaps, the report said.
The shift toward electronic trading is discouraging dealers from working on large trades because platforms are less suited to handling them, BIS said in a separate report. This trend, which also reflects stricter capital rules, has made trading large amounts more complex and time-consuming, it said.
Automated market makers are often able to provide competitive quotes, even when markets are volatile, the BIS said. Still, the gap between bids and offers, known as the spread, may be less useful for assessing markets with widespread automated trading. Alternatives include measuring the total cost of taking a position in a security of a certain size, it said.
The BIS also said there was no “smoking gun” to suggest that high-frequency trading caused recent unusual price moves, or “flash events.” These include examples in the Treasury market in October 2014, in German bunds in June 2015 and Japanese bond gyrations in March 2014.