US Corporate Bond Trading 2013: In Search of a New Market Structure

Danger signs in the corporate bond market are flashing like a lighthouse’s beacon. Issuance is at an all-time high, dealer inventories are at an 11-year low, and regulators are reducing leverage through Basel III and the Liquidity Coverage Ratio (LCR). The market and liquidity risk historically held by dealers now squarely rests with investment managers. With the threat of tapering looming, a shift in interest rates could be traumatic, especially if the corporate bond market structure does not function properly.

The challenge is that the current OTC market structure revolves around dealer balance sheets and leverage, which today are under siege by regulators and are being scaled back by bank management. This is pushing the traditional capital-intensive and voice-based market toward electronic channels. While the existing electronic players are active, well used, and supported, many of the current structures revolve around existing dealer business models. That leaves the corporate bond market with unmet needs and significant challenges. The market is crying out for new alternatives to trade credit.

TABB Group research finds that there is demand for a market structure that allows diverse sources of liquidity to find one another. There is no desire to disrupt the current issuance model, the role of the dealers in providing capital, the value of existing relationships, and decades of legacy processes, data, and technology structures. That said, improving liquidity in 70,000 corporate bond issues (CUSIPS) is a Herculean task. Any new market needs capital, which dealers currently provide. So increasing liquidity will necessitate either new entrants to start providing liquidity, or else buy-side credit traders, who are accustomed to taking prices, have to begin to make them. Solving these issues will take investment, guts, and breaking (or at least bending) established business models. While many buy-side firms voice the opinion that the challenges are sufficient enough to foment change, the catalyst for action is not in sight. The time may be ripe for a new corporate bond trading platform or protocol to emerge to challenge the status quo. More than three-quarters of the buy-side firms we spoke to say now is the time for an Alternative Trading System (ATS) to emerge to take market share away from the traditional OTC market dealers and existing electronic platform providers. Opportunity, anyone?

This study was conducted in the early autumn of 2013 and includes findings from conversations with a number of the largest US asset managers and the largest corporate bond primary dealers to ask them for their thoughts on corporate bond trading market structure. We talked with heads of trading and/or senior traders at 13 of the largest asset managers with an average corporate bond AuM of $129 billion, and the global heads of credit or heads of credit e-commerce at 12 of the largest dealers.