Electronic platforms and markets have solidified their presence in U.S. corporates over the last 10 years, but their liquidity has largely plateaued, certainly relevant to new issuance. Still, current trading conditions don't bode well for sustaining the manual (voice) and principal (proprietary) trading traditions of the corporate bond market. Furthermore, the diversity of options for market participants about where market structure is headed might best be characterized as schizophrenic.
Even with all of these obstacles and options for market participants, perhaps the market structure is actually in the midst of a tidal change. Electronification may be set to happen fast and, together with agency trading, fill the liquidity gap that the slowing down of new issuance and diminished sell-side inventory and principal trading have left. If so, it's reasonable to expect that in the absence of a fast market, new tools for valuation and managing internal markets will also come to the fore as traditional reliance on sell-side principal trading wanes.
In 2002, in an effort to introduce more transparency into the corporate bond market, the National Association of Securities Dealers implemented Trade Reporting and Compliance Engine, or TRACE, which tracked trading in the secondary market of U.S. corporate bonds.
TRACE is now managed by the Financial Industry Regulatory Authority and provides for post-trade price transparency in U.S. corporates, currently 15 minutes after the trade. TRACE proves to be a rough equivalent in functionality to U.S. cash equities' printing to the tape. One could argue that TRACE reporting, which is now 11 years old, was roughly the last major innovation in transparency for U.S. corporates.
Prior to TRACE, U.S. corporates pricing was largely opaque, with market participants having to call from desk to desk to get prices. Only through the participants' own polling could they establish pricing -- sometimes actionable, other times purely indicative -- and attempt to determine their best tradable price.
With TRACE, all prices and sizes of trades became public after the fact, which induced pressure on pricing throughout the trading workflow. By some estimates trade execution costs (i.e., premium to par value) were cut in half. Initially TRACE was only available for a subset of all the bonds traded. But even for those bonds not reported on TRACE, execution costs went down. Today, with all trades subject to reporting, post-trade transparency is in full effect for U.S. corporates.
U.S. corporates electronic trading platforms started in the late 1990s and cemented their foothold in 2002 when TRACE went live. Since then they've steadily gained ground, with several mergers along the way. There are four different types of platforms, based on the market participants that use the technology:
Dealer-to-dealer: D2D or interdealer markets are only open to sell-side broker-dealer participants and typically transact in the largest sizes. Interdealer brokers facilitate trading solely between sell-side participants. The largest are BGC, GFI, ICAP, Tradition and Tullett Prebon.
Dealer-to-customer (D2C): Many of the sell-side players, particularly the largest banks, have their own electronic systems -- known as single dealer platforms -- to communicate and trade directly with just their customers. Some SDPs have added capabilities that enable matched principal trading between their customers. Beyond the voice dealer boards and SDPs, there are also a variety of D2C platforms with multiple dealers and customers, known as multidealer platforms.
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Participant-to-participant: P2P platforms attempt to treat all participant types equally and are epitomized by registered exchanges. However, P2P platforms can be electronic communication platforms and markets as well. While generally they're based on a central limit order book, it's conceivable to have a request for quotation (RFQ)-based P2P platform.
Customer-to-customer: C2C platforms are open only to buy-side participants, just as D2D markets are restricted solely to sell side. The concept behind them is to disintermediate dealers and any "dealing" component in the trade to narrow spreads and increase tradable size. Naturally, only the buy side is in favor of C2C platforms.
While retail-oriented electronic platforms abound in U.S. corporates and some banks' electronic platforms are beginning to proliferate, Bloomberg and MarketAxess have been the main players in the institutional space. Incidentally, both Bloomberg and MarketAxess are RFQ platforms. Bloomberg is strictly a price discovery tool, whereas MarketAxess is a registered market. Beyond these platforms, institutional trading is done via mostly nonelectronic means, through voice, email and instant messaging. Based on this, it's reasonable to use MarketAxess as a proxy for pure electronic trading.
Given MarketAxess' reported volumes as a percentage of TRACE volume, it continues to make evolutionary progress in its market share, as well as reaping the benefits of TRACE's modest volume increases. MarketAxess has deep penetration in the institutional market on both the buy and sell sides. In fact, the sell-side penetration is increasing as well. So as a mature platform, MarketAxess' volume increase is attributable to the overall growth in electronic trading.
While overall the U.S. corporates market is soaring, electronification rates clearly are not. However, fresh institutional indications of interest in some of the smaller electronic platforms, even in the retail space, may be a harbinger of more electronic trading to come.
David B. Weiss is a senior analyst at Aite Group. He covers global listed and OTC derivatives, electronic trading, SEFs and OTFs, global financial regulation and capital markets intellectual property with a subtle focus on trading technology.