Wall Street's Fear of the Computer Drops in Bond Market SurveyBy
Bank traders grow more comfortable amid regulatory shift
Greenwich Associates finds banks still dominate bond trading
Among the few constants on Wall Street such as bonus season and empty desks in August add this: with every year that passes, traders are getting more comfortable buying and selling corporate bonds electronically.
That’s the conclusion of a new report by Greenwich Associates LLC, which polled debt traders in the U.S. and Europe on whether computerized trading posed a risk to their business. The percent who answered “yes” has fallen by more than half since 2015. External causes are driving the shift, according to Kevin McPartland, the head of market structure research at Greenwich Associates who wrote the report.
Faced with regulatory changes that have diminished their ability to buy as many bonds from customers as they want, bankers are still willing to do smaller deals electronically rather than lose the business entirely, he said.
“In some ways electronic trading is the next best option to how they did things in the old days,” McPartland said in an interview. “They still might not love it, but they’re accepting it as it is and taking it at face value.” Retail trades in the market, typically defined as orders under $1 million, have gone fully electronic, so the gains in computerized buying and selling are coming from institutional investors, McPartland said.
While about 20 percent of all trades are now done entirely by computer, the analyst thinks only about a third of the market will ever go fully electronic. “It’ll be hard to get beyond that” because with bigger trades, institutional investors want to speak to brokers, who can offer more hand-holding and can help clients avoid tipping their hands about their positions to the broader market, he said.
Embracing the change in buying and selling bonds has been much slower than in futures or stocks because corporate bonds aren’t well-suited for computerized trading. Still, there are other signs of a gradual shift.
Tradeweb Markets LLC, a derivative- and bond-trading system owned in part by banks including Goldman Sachs Group Inc. and JPMorgan Chase & Co., has recently grabbed 1 percent of electronic trading in the overall U.S. market. While tiny, that shows the firm is gaining traction, a rare accomplishment for startups trying to upend the status quo. Several firms have tried to popularize bond trading over computers, including Goldman Sachs, BlackRock Inc., MarketAxess Holdings Inc., DirectPool and a slew of bank-led consortiums with code names like Oasis and Neptune. Not many have succeeded, partly because dealers were worried they’d weaken a lucrative segment of their business if trading changed too much.
The Greenwich research found that 21 percent of bond dealers now view electronic trading as a threat, down from 46 percent who said the same in 2015. During the same period, the share of bankers who said they view it as an opportunity rose to 58 percent from 54 percent. To gather its data, the financial-services consultant interviewed 46 fixed-income traders and sales executives in the second quarter, of which 35 percent worked for the largest global dealers -- known as the bulge bracket -- with the remaining at middle-market and regional dealers.
“Whereas the bulge-bracket banks are more concerned with rising costs and limited balance sheet, regulatory concerns are particularly acute for the middle-market dealers,” McPartland wrote in the report. Three out of four regional dealers said complying with new regulations was their biggest challenge to success in the coming year, McPartland found.
To this end, the U.S. Treasury last month identified areas in new banking rules that could be eased to help smaller firms. One of the recommendations was to increase the size of a bank that would trigger annual stress tests mandated by the Dodd-Frank Act. The U.S. said in June those test should apply to banks valued at $50 billion or higher, up from $10 billion.
Smaller regional banks are gaining traction in the market, McPartland said. About 96 percent of investors reported trading investment-grade corporate bonds with regional dealers, giving on average 15 percent of their business to these banks, he said. Still, the largest dealers still dominate the bond market, a trend that hasn’t changed since at least 2008. The largest 10 banks account for 90 percent of trading of investment-grade bonds, and 92 percent of high-yield debt, according to the report. In 2008, the numbers were 88 percent and 93 percent, respectively.
“Most of the time, trading tends to be large and institutional,” McPartland said. Investors “need dealers to stand in the middle,” he added. “Relationships are still a huge part of the market.”