Investors See Themselves as Market Makers in Corporate Bonds

More than half of institutional investors now consider themselves de facto market makers in corporate bonds as banks pull back.

That’s the finding of a report from Greenwich Associates based on interviews with 58 investors from the U.S. and Europe. About half the survey respondents expressed interest in plans that would allow dealers to access investor holdings for a fee in order to boost trading.

“I was probably surprised at how many of the investors said they thought the buy-side was a good resource of liquidity and how many said they were proactively making prices,” said Kevin McPartland, who heads market-structure research at Greenwich Associates.

Corporate-bond inventories held by the Federal Reserve’s 22 dealers have plunged since the financial crisis as tougher regulations make it more expensive for banks to hold riskier assets.

Three-fourths of the respondents said they’ve seen a pullback from the biggest dealers in providing liquidity in the past year and more than half expect further declines.

To weather these changes the smartest investors are turning to electronic trading and using tools such as exchange-traded funds and credit default swaps, according to the report. Some buyers are avoiding the secondary market entirely.

Buyside Inventory

“It’s so well-known now that the buy-side holds all of the bonds,” McPartland said. “Maybe there’s some way that the sell-side who doesn’t have as much balance sheet as they used to could tap into that inventory and use it to keep the market fluid.”

Adjusting regulations to allow banks to hold more bonds would almost certainly open up the market, though McPartland said investors should consider other ways to keep credit flowing.

“That is the ideal solution, but don’t expect it,” McPartland said. “If it does happen, it’s going to take years, so we have to deal with what we have right now.”