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Capital Markets Outlook 2013: Upheaval in Fixed Income

Electronic trading is gaining traction in fixed income as capital-constrained dealers and new rivals seek ways to offer liquidity to the buy side.

Why It's Important: Regulations such as Basel III in Europe and Dodd-Frank's Volcker Rule here in the United States, coupled with revenue pressures, have led Wall Street banks to reduce their inventories of bonds. Regulation has constrained the dealer's ability to use its balance sheets to make markets in corporate bonds.

"There's essentially a traffic jam in fixed income," observes Ben Macdonald, head of global fixed income at Bloomberg. Dealers are less likely "to park bonds on their balance sheets," and they no longer have the scale they used to, he says.

In corporate bonds, dealer inventories are reportedly down by 80 percent since 2007, forcing institutional investors to actively seek new sources of liquidity. "Electronic trading is a means to connect more buyers and sellers, and we want to develop a marketplace to get liquidity flowing again," Macdonald says.

Where the Industry is Now: Only 36 percent of U.S. institutional investors trade fixed income electronically, and electronic systems capture just 25 percent of overall fixed income trading, according to consulting firm Greenwich Associates. However, partly to cut costs on their trading desks, which are earning lower profits, dealers are shifting from voice trades conducted over the phone to electronic trading. Credit Suisse offers an automated trading system for U.S. Treasuries.

Now attention is turning to corporate bonds, which have thousands of different names and less liquidity. Several dealers have crossing initiatives under way in corporate bonds. According to a story in the Financial Times, Goldman Sachs GSessions and Morgan Stanley Bond Pool are conducting "eBay like auctions," looking to bring together clients who want to buy or sell specific corporate bonds at certain times. But these efforts are also meant to keep customers from going to rival platforms. Asset manager BlackRock is building the Aladdin Trading Network, an alternative trading system to match bonds between pension funds, endowments and other institutional buyers and sellers, without a dealer in the middle.

[Dangers of the Dark?]

Meanwhile, alternative upstarts are diving into the fixed income space. Unlike e-bond trading platforms based upon a request for quote (RFQ) model, in which the buy side goes online and asks up to five dealers for a quote, Bonds.com allows anonymous trading based on continuous bids and offers. In October, Vega-Chi, a European firm, launched a U.S. high-yield bond-trading platform targeting the buy side to enable trading in an "exchange-like" setting without sell side intermediaries.

Focus in 2013: Since there's a real estate issue on the buy side desktop, focus for next year will be the aggregation of streaming price feeds from multiple liquidity providers. Bloomberg has the ability to aggregate prices on all the single dealer pages to create an order book. A client using this All-Quote feature "can see an order book of all the prices that different dealers have and trade on those prices," Macdonald says.

Industry Leaders: MarketAxess and Tradeweb are the main players in electronic fixed income trading. But they represent the incumbent RFQ model, where institutions query up to five dealers for prices. Newer alternative trading systems, including Bonds.com and Vega-Chi, offer a continuous trading model with anonymity and live, executable prices. Also, Bond Desk's ATS is the largest in facilitating retail order flow.

Technology Providers: Execution management systems like FlexTrade Systems have begun offering connectivity to different liquidity sources. The FlexTrader EMS accesses streaming prices in Treasuries from BGC Partners' proprietary eSpeed platform. In September, newcomer iTB Holdings launched an EMS called iTBconnect specifically to help institutional investors access multiple fixed income venues through one API. "In one central location, you have all these eyeballs who can engage in your order, which opens up the possibility that you can get a better price and a better execution," says Michael Chuang, CEO of iTB Holdings.

Prediction: "Parts of fixed income are starting to evolve to an all-to-all trading market. It won't be as bilateral as in the past," says Bloomberg's Macdonald.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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