A Tale of Two Platforms …

The Week That Changed the Corporate Bond Market

Over the years, there have been two camps on corporate bond market structure that hold very different opinions. One group has steadfastly promoted the idea that innovative solutions have improved corporate bond market trading conditions (“we don’t believe there is a liquidity crisis whatsoever”). The other group has warned that the relative calm we’ve enjoyed in the market over the past decade, thanks to central bank intervention, has masked material structural issues that will have negative consequences on corporate bond market liquidity.

The week of 3/16 to 3/20 has exposed which group has been woefully mistaken.

I Know What You Did Last Week

Horror movies are good clean fun because eventually, the credits roll, and you can return to a world where super-natural monsters aren’t behind every door. Horror markets are longer lasting and far more detrimental to your psyche. To be clear, a substantial downturn in market value is not what terrifies market participants because volatility creates opportunity. What causes real panic in any market is when trading conditions deteriorate to the point where trade execution is severely compromised. When this occurs, both buy-side and sell-side institutions face the same situation. It’s a crowded room, and the exits are blocked. Now you’s can’t leave.

Stand Clear of the Closing Doors 

An examination of last week’s corporate bond transaction data (TRACE) illustrated three clear trends that demonstrate a meaningful deterioration of corporate bond market trading conditions:

Downward Trend in Trading Volume

Since US corporate bond markets became volatile on 2/24, we have witnessed an increase in the average daily volumes. The week of 3/16 to 3/20 was still incredibly volatile, but volumes showed signs of retreating in both investment grade and high-yield markets. Meanwhile other financial markets have been experiencing record trading volumes in response to the heightened volatility.

Contraction

A topic that has received very little attention in the corporate bond liquidity discussion is CUSIP concentration. Looking at volume and bid/ask spreads do not tell the whole story on trading conditions because those metrics omit analysis on what is available to trade. Increasing volumes over a smaller universe of CUSIPs would produce signals that give a false sense of liquidity in the market:

In conclusion, the price-based liquidity measures—bid-ask spreads and price impact—are very low by historical standards, indicating ample liquidity in corporate bond markets. This is a remarkable finding, given that dealer ownership of corporate bonds has declined markedly as dealers have shifted from a “principal” to an “agency” model of trading. These findings suggest a shift in market structure, in which liquidity provision is not exclusively provided by dealers but also by other market participants, including hedge funds and high-frequency-trading firms.

(Has US Corporate Bond Market Liquidity Deteriorated? – Fed Blog, Liberty St Economics Oct 2015)

This is not a “remarkable finding” when you consider the declining breath of trading as a factor.

Looking at the total number of CUSIPs traded on a weekly basis, the week of March 16^th was down ~14% or almost 2,000 CUSIPs from the weekly average of the previous five weeks:

It is not hard to imagine how CUSIP concentration has the potential to spiral. With a smaller universe of bonds trading in the market, there are less TRACE prints for CUSIPs that are not actively traded. The longer non-active bonds go without transaction data, the harder they are to trade, which exacerbates the concentration issue even further. To think, less than a year ago, there were loud voices in the market asking for a reduction in the dissemination of transaction data. Wow.

Reversal of Customer Flows

An interesting phenomenon that we covered in a previous research note was how customer flows have remained positive in the face of COVID-19 pressure. From 2/24 to 3/13, buy-side institutions were net buyers of corporate debt with a net purchase volume of $19.1B during the period. Positive customer flows were observed in every sector. In contrast, the week of 3/16 to 3/20 had negative customer flows with net sales volume of $3.6B. Positive customer flows were only observed in 3 out of 10 sectors. This reversal has gained momentum going into this week, with $9.4B net sales imbalance from the 23^rd to the 24^th with every single sector showing negative customer flows.

This combination of lower volumes, less CUSIPs trading and negative customer flows raise an important question: What is happening with all the new ideas that were promoted as solutions to US corporate bond trading problems?

Are We There Yet?

There have been many exciting articles and announcements about transformative innovation in the corporate bond market. Let’s see how some concepts are holding up post 2/24:

Algorithmic Corporate Bond Trading

For several years, algorithmic trading has been touted as the future for the corporate bond market, with dealers gaining more and more confidence in the capabilities of automated decision making:

At first the “Goldman Sachs Algorithm” only handled trades below $500,000, but today anything below $2m “doesn’t get touched by a human”, according to Justin Gmelich, a senior executive at the investment bank. “In four-five years I wouldn’t be surprised if we have a lower trader headcount, and have more staff on the algorithmic side,” he adds. 

(Bond Trading Technology Finally Disrupts a $50tn Market – FT May 2018)

 

Several sources in the market have stated that “all the algos have been turned off,” which is an ominous sign for their reliability during times of persistent volatility. This is not the case in other markets that have leveraged algorithmic trading techniques for years (ex: FX, Equities, TSYs, Futures, Options). The common denominator for consistency of algo trading is the quality of data used to maintain the pricing engine. In the corporate bond market, there is a dearth of high-quality pricing data to begin with. During times of high volatility, accurate information in the corporate bond market becomes scarce.  Without improving the pricing inputs for corporate bond trading algos, they will forever be subject to service disruptions.

Platforms Providing Liquidity

Most of the dialogue on corporate bond market structure is provided by people that have a solution to sell, current company included. Therefore, it is no surprise that a narrative that electronic trading platforms provide liquidity has been gaining momentum over the years:

In the absence of large dealer participation, New York-based MarketAxess has sought to plug the liquidity gap with its proprietary electronic trading platform, providing investors and broker dealers with streamlined access to an array of fixed-income products, Dave Simons talks to Rick McVey, MarketAxess chief executive, about the opportunities and challenges of the segment” 

(MarketAxess Plugs the Liquidity Gap – MarketAxess September 2014)

 

The act of providing liquidity means that you are in the business of facilitating opportunities for those who seek to transact, so in a sense, yes, MarketAxess and other trading platforms could be considered liquidity providers. However, when you claim that your platform is going to “plug the liquidity gap” because dealers have stepped away from the market, you are implying that the electronic system itself acts as a risk-taking counterparty to facilitate transactions. This is extremely misleading and sets irrational expectations on what problems e-trading platforms really solve (hint: efficiency of trading).

It is dealers that are the engine of liquidity in the corporate bond market, regardless of whether the transactions occur by phone, electronic trading platform or smoke signals. If dealers back away from the market, liquidity is removed from all venues, including trading platforms. If electronic trading providers want to deliver a resilient liquidity solution, it requires consistent dealer participation. Improving access to pre-trade data for dealers is a proven technique that fosters dependable market making activity for both voice and electronic execution.

Model-Based Pricing

The absence of high-quality pricing data in the corporate bond market has created an environment where numerous model-based pricing solutions have taken hold. These solutions determine the true value of a bond by, “leveraging the relationships between bonds; based on factors such as liquidity, maturity, time since issuance, amongst other things.” While this process for determining the value of a bond may sound more like art than science, model-based pricing is the only game in town for calculating best-execution, transaction costs and most importantly, portfolio valuations. Just before the COVID-19 crisis, a new model-based pricing product had claimed a breakthrough in accuracy:

The pricing engine’s algorithm consumes more than 200 features and produces an unbiased, two-sided market for 95% of the tradable universe which is updated every 15 to 60 seconds, depending on the liquidity of the instrument. “The predicted prices of CP+ track traded levels very closely, and we aim for zero average difference between the two,” said Krein. “A real-time accurate pre-trade reference price for corporate bonds has not been available before.”

(Second Revolution in Electronic Bond Trading – Traders Magazine, February 2020)

While it would be great to believe that science can solve the mystery of accurate corporate bond prices, today, all model-based solutions float on an ocean of poor-quality information, so accuracy and reliability of bond portfolio valuations can be compromised. Post-COVID-19, this flaw became abundantly clear for bond funds and ETFs:

Carnegie Fonder, which shuttered a number of funds on Friday, required additional time to reach out to banks in order to determine prices. In an announcement to clients it wrote, “[We] decided to suspend trading in funds that invest in corporate bonds. As a consequence of the substantial turbulence in the market, there was a risk that the valuations (NAV) could be incorrect. It is our duty to ensure that valuations of the funds’ holdings are correct. During Saturday we reviewed all our portfolios and all their holdings.”

(Bond Pricing Battle Shutters Nordic Funds – The Desk, March 2020)

The first thing is that I took some comfort seeing that the trading was going on below net asset value (NAV)—BND was trading at a discount, I thought. For example, BND closed at $80.33 on March 12, 2020, while Morningstar shows a NAV of $85.61. That difference is huge. Unfortunately, Ben Johnson, Morningstar director of global ETF research, burst that bubble for me. He told me the NAV is based on stale prices for the bonds in the portfolio; thus, it is a bit like clocking the Olympic 100m dash with a stopwatch that only counts in 10-second increments.

(Why High Quality Bond ETFs Failed Us – ETF.com, March 2020)

There is approximately ~$10tn in outstanding US corporate bond debt. COVID-19 has exposed the fragility of the model-based pricing valuation process. This is not due to a lack of effort or technique on the part of model-based price providers. Like algorithmic corporate bond trading, high-performing, accurate model-based pricing solutions require consistent high-quality pricing data as an input.

Imagine

The innovation effort in the corporate bond market has not been in vain. There has been remarkable progress in electronic trading, algo strategies and model-based pricing. However, these solutions float on a sea of poor-quality pricing data that ultimately impairs their effectiveness when they are most needed. Imagine if the US corporate bond market had the same architecture as other modernized markets: a functioning, centralized pricing platform that improved the quality, access and reliability of price data.

At BondCliQ, we are singularly focused on improving transparency for market makers to produce the missing architecture for corporate bond market modernization: high-quality, centralized pricing data. Our approach is based on 50 years of financial market structure history. This past Friday, we had the privilege to present the details of our initiative at The Future of Market Technology Symposium hosted by Autonomous Research (Click here for video presentation of ‘Transparency and Market Liquidity’). As adoption of BondCliQ grows, imagine the positive impact the resulting data will have on dealer performance, electronic trading, algorithmic strategies and model-based pricing solutions. Now imagine what those improvements would mean for corporate bond market liquidity.

-Chris White

Corporate Bonds in the Time of the Coronavirus – What story does the data tell us?

The last week of February 2020 was a reminder that markets can and will go negative. Courtesy of the Coronavirus, global financial markets saw a “prolonged correction” in every major equity market:

• The S&P 500 had its worst week since 2008 (US – NY TIMES)
• The pan-European Stoxx 600 lost 12.7%…the worst since October 2008 (EU – CNBC)
• Both the Shenzhen composite and Shenzhen component dropped nearly 5% on Friday (Asia – CNBC)

I had the honor of being invited to speak about the impact of the Coronavirus on the Yahoo! Finance news broadcast on Friday. As I watched the show before my segment, they kept flashing real-time updates of the carnage in equity markets, but not a single piece of information existed on corporate bonds. Not a profound observation in the least, but it still amazes me because the US corporate bond market is bigger and arguably more important than the stock market.

Luckily, we (BondCliQ) have the transaction data (TRACE), so our February blog post is dedicated to re-telling the story of last week, in data (and pictures).

Nobody Move, Nobody Gets Hurt

The beginning of 2020 set a record pace for new issuance:

Corporations rushed to sell $69 billion in investment grade debt this week, the second-highest amount ever in a one week period, according to BofA Securities.

Companies Issue HG Debt at one of the Fastest Paces Ever This Week – CNBC, January 10^th, 2020

By the middle of last week, it was clear that the first casualty caused by the Coronavirus for the corporate bond market was the new issue calendar. Most if not all deals were canceled:

In the U.S., Wall Street banks recorded their third straight day without any high-grade bond offerings, a rarity outside of holiday and seasonal slowdowns. European debt bankers had their first day of 2020 without a deal on Wednesday. And bond issuance in Asia, where the virus first emerged, has slowed to a trickle.

Global Credit Markets Seizes Up As Coronavirus Halts Bond Sales – Bloomberg, February 26^th, 2020

Delaying new deals isn’t so unusual for the corporate bond market, but the Coronavirus does beg a critical question for some of the less creditworthy borrowers: How long will I have to wait?

Red Rain is Coming Down…

So, how bad was the week for US corporate bonds. Using the BondTiQ application we can visualize the entire week of corporate bond trading activity (Feb 24^th to Feb 28^th):

From the looks of it, no portfolio was safe as the top 20 names by volume in each sector saw their underlying bonds lose value. The only exception for the week was Mallinckrodt, a CCC- rated, a generic drug manufacturer that agreed to settle an opioid lawsuit for $1.6 billion. Distressed bond trading is weird…

If you can keep your head about you while all others are losing theirs…(R.Kipling)

While the US corporate bond market certainly lost value, institutional investors were not panicking in the slightest. If we examine institutional transactions (>=$1MM) for the entire week, buy-side clients were net buyers of corporate bonds by a difference of almost $9 billion in notional volume:

This image illustrates why it is critical that corporate bond market data be included in the broader discussion on financial market performance. While the stock market can be relied on for accurately reflecting the present feelings of investors, the bond market articulates the longer term financial market outlook. Undoubtedly, buy-side institutions treated last week as an opportunity to pick up yield and were not dismayed by the Coronavirus.

There is even more evidence of market support when we look at the market on a sector and maturity basis. For the week, long end (>=10yr), investment-grade Financials also had positive client flow, especially for the top four issuers by volume:

Clients were net buyers of 13 out of the 16 most active issuers when looking at this section of the market. Maybe they were pricing in what is already being predicted this week, a central bank rescue plan to get markets back on track. Undoubtedly, this is a windfall for the banks, just like every other QE initiative post-2008.

Darkness Cannot Drive Out Darkness; Only Light Can Do That…(MLK)

One thing that all institutional corporate bond market participants know is that when volatility really picks up, data is at a premium. The inability to quickly capture, organize and sift through TRACE data leaves you reacting in an environment that presents meaningful opportunity. The browser-base application that created these images/insights, BondTiQ, is the most powerful tool for leveraging TRACE information. Let us help you get an edge.

If you are interested in a free trial for you and your desk, reach out to us at info@bondcliq.com.

-Chris White, BondCliQ CEO

Buy Side New Year’s Resolution – Changing Your Corporate Bond Data Diet

Every January begins with resolutions of new routines designed to create a better version of yourself. Read more books, learn something new each day, meditate each morning, etc.

This ritual is a rare occasion when your future self is in full control and sets the agenda that your present-self must follow. Typically, it is the other way around. We favor our present self to the detriment of our future self. A late-night pint of ice cream may feel good at the time, but you’re paying for it later.

Week’s after New Year’s resolutions have been established, the bad habits gradually return. You may get through a dry January, but come mid-February, the present self is back in control, and immediate satisfaction is all that matters (it’s Wine O’Clock baby!).

As the US corporate bond market enters 2020, there is one resolution that buy-side institutions must not break: Improving their institutional corporate bond data diet.

Because the data you consume now will have an impact on your future performance.

I did it! So can you!

Celebrities are often the face of campaigns about weight loss and fitness, but their approach is costly to replicate. Personal chefs, personal trainers, and a steady supply of organic food are at their disposal. With such an edge, it is no wonder that they can rapidly and dramatically lose weight and get fit.

The buy-side landscape for institutional pre-trade corporate bond data is very similar. Over the past few years, some of the largest asset managers have been focusing on enhancing the value of pre-trade institutional, corporate bond data. These organizations have committed sizable technology resources to produce their own, proprietary pre-trade data. Their pricing information is superior in quality to what other asset managers use (IMGR, model-based prices, etc) because they capture as much information as possible, and then test and analyze the data to remove inaccurate markets and poor performing dealers. Once complete, these advanced asset-managers have a steady diet of higher-quality pre-trade data to improve their trading process, where it matters most, block execution:

“The key to best execution is having better information before you trade, and that’s what Alfa is delivering to us,” says James Switzer, global head of credit trading at AB. “We see more transparency than almost anybody.”

Risk.net – December 2016

Killer Carbs!

Access to pre-trade institutional data is not the issue for the buy-side community. There is a great deal of information available, but a material amount of institutional pricing is like junk food. It may look good and taste good, but there is no nutritional value for actual trading:

Believing what’s on the screens; and that goes for PMs and traders. Sometimes there is misinformation there and it can paint a false picture of what’s truly available, or what the true price would be.

The Desk – January 2020

Putting bad information into your front office applications (OMS), risk systems and analytical tools will bloat and distort your view of the institutional market. Bonds will appear to be more liquid than they are and assumptions about the cost of trading will be much smaller than reality.

Avoid GMO Data

Knowing where the data comes from is very important question for buy-side institutions. Beware of products in the market that may look like a quick fix solution for high-quality institutional pricing. Several vendors capture and present dealer prices without the knowledge of the dealers. In the long run, this presents a fuzzy, but serious dilemma for any buy-side client that builds their systems and tools around ill-begotten data sources. Like Napster, at some point, the music will stop because those vendors do not have the right to productize information that was not intended for their consumption. When that happens, the buy-side institutions that relied on these sources will have to scramble to find a replacement provider and may have to forfeit their invaluable catalog of historical data.

Keto-Friendly Bond Data

For buy-side institutions to get the results of a leaner and more effective block trading process, it starts with ingesting the proper pre-trade data. BondCliQ has developed an institutional pricing source that produces high-quality data without buy-side institutions bearing the burden of high costs and substantial IT resources. Our platform is a “Farm to Table” solution that delivers pricing information directly from participating corporate bond dealers to your firm. We improve the health of your front office applications, risk systems, and analytics by creating an environment where institutional data will get better over time. What more do you need to keep this New Year’s resolution intact?

-Chris White (CEO, BondCliQ)

Stand and Deliver – The Path to Executable Institutional Pricing in US Corporate Bonds

Judging the quality of corporate bond market data is a subjective process, especially when it comes to assessing the reliability of pricing information. Multiple factors like venue, time when the market was posted, size displayed, and the identity of the provider go into the equation that determines whether a price is dependable for trading. However, the feature that seems to trump all other inputs is whether the price is “executable” which means it can be traded electronically “on screen.” In other markets, a live price is considered an “order,” which means there is no last look afforded to the person who posts the market. Once someone tries to hit or lift the price, the trade is executed. Many corporate bond platforms have tried to convert indicative prices into “order-driven” executable markets, but the same issue ultimately prevents this from happening: backing away.

Backing away is when a price provider does not stand up to their market. This practice is in no way unique to electronic trading and happens all the time for both large and small transactions. If it wasn’t for backing away, we wouldn’t need lawyers when closing on a house and pinky swears would become a relic of the past. For capital markets, when a price is posted electronically and appears to you on screen, there is a natural expectation that the market is real. However, creating an environment where dealers will stand and deliver liquidity against their posted prices is not easy.

Bust a Deal and Face The Wheel

To many, breaking a deal, any deal requires serious consequences to deter others from repeating the same offense. In the early days of financial market systems, an individual’s honor and reputation were the only collateral because there was little to no technology to enforce market integrity. This explains the old London Stock Exchange Motto: Dictum Meum Pactum – My Word is My Bond.

There is a growing assumption in the corporate bond market that technology and e-trading alone will ensure price integrity, but this has proven to be incorrect across multiple markets

Those Were the Days…

Nostalgia is a funny thing because it tends to distort the truth by presenting past events or eras as if they were much better or worse than reality.  The stories of how it used to be are most often told to those who lack firsthand experience, so facts rarely get in the way of the storyteller’s perspective. Recount a story enough times with enough distance between the past and the present, and the lines between someone’s view and real history start to blur. This isn’t a problem when people discuss something inconsequential like their old high school athletic career. However, when a nostalgic view of the past is treated as a guide for the future, mistakes can and will be made.

Those Who Do Not Learn History Are Doomed to Repeat It

Great quote, but when it comes to corporate bond market structure, many of today’s ideas are designed to repeat the historical successes of other financial markets. For example, recent comments from a representative of a leading corporate bond electronic trading platform suggest that investors could “save billions” if participants started working executable orders for corporate bonds…like they’ve done in equities:

“The concept of working orders still hasn’t reached the fixed-income market. I think there will be a lot of evolution around how clients can put some orders in the machine and work the larger, more complex orders. Innovations like that, or around how investors price bonds, are areas where the bond market can see big benefits from taking inspiration from how equities trade. Investors would save billions.”

To translate a bit here, the concept of “working orders” in a market assumes that there is at least one well-functioning electronic order book to rest an order. In addition, putting some of those orders “in the machine” assumes that there are MULTIPLE well-functioning orders books, which would allow the investor to realize the benefits of smart order routing. Now it is not a huge leap of faith to believe that an electronic order book could be built and launched for the corporate bond market. Multiple ECNs like Tradeweb Direct, TMC, MTS Bonds, UBS Bond Port and Knight Bondpoint have successfully established platforms that closely resemble order books with reliable markets for small sized (<$250k) trades. What this neat and tidy vision of corporate bond market evolution fails to acknowledge is that establishing price integrity on a broader scale is very difficult. We know this because back in the day, the US equity market struggled with the exact same issue of backing away. So while it sounds great to say that billions could be saved if we followed the path of equities, that path is long, difficult and not achieved by simply launching a platform with “live markets.”

The Market That Time Forgot 

I was recently reading a few old articles about market structure which is just a slightly more exciting hobby than stamp collecting. Every now and then I find content that can be best described as a time capsule because the market structure conditions and practices being discussed are all but forgotten. A great thing about historical content is that we know how the story ends so we view the information with full knowledge of the eventual outcome. The title of this excellent Los Angeles Times article from 1994 is very wordy and leaves very little to the imagination:

The Price of Backing Away: NASDAQ Market Makers Often Don’t Honor the Prices They Display. Complaints Abound, But NASD Says Most Are Frivolous. This sounds oddly familiar to the current state of the US corporate bond market where execution quality can be suspect.

If you’ve assumed that the good old days of electronic trading in equities meant reliable prices, then there are a few startling statements in the 1994 Los Angeles Times article:

• “Federal regulation–what’s known as the “firm quote rule”–requires market makers to honor the prices they display.” Backing away was prevalent in a market that had a federal regulation prohibiting the practice.

• “Through Oct. 4, traders had filed 4,748 complaints this year alleging Nasdaq market makers “backed away” from their obligation to trade at posted prices.” Almost 5,000 complaints had been filed YTD. Assuming that approximately 180 trading days had passed, there were an average of over 25 complaints of backing away every day. That may not sound like a lot, but this is only tracking violations that were formally reported. It is not hard to imagine the true daily average being a multiple of 25.

• “While James M. Cangiano, the NASD’s executive vice president for market surveillance, insists the group takes backing-away complaints “very, very seriously,” the NASD confirms that it has taken no public action in response to any of the complaints filed this year.” There were no real consequences for backing away.

• The trader offered to sell the shares to Morgan Stanley & Co., the giant Wall Street investment bank, which is also a major Nasdaq market maker. At that moment, Morgan Stanley had the best posted “bid” price for Intuit, offering to pay $49.25. Morgan declined to fill the order. But for at least 12 minutes after, the firm continued to post the $49.25 price, seemingly indicating that it was ready to take any legitimate offer at that price, as the firm-quote rule requires. Rule breakers were bold and unafraid.

The Anatomy of Backing Away

It is very easy to place the blame of poor price integrity at the feet of the market maker. After all, they are the ones who posted the price in the first place, so it is they who must honor their market. This view assumes that backing away is caused by poor integrity alone which is missing the full picture. Yes, there are definitely market makers who post prices with no intentions of trading, but another major driver of backing away is protection. Not all people who take liquidity do so with the best intentions, so backing away functions as a safety valve. We see this directly in the LA Times article when the author provides details on who was making the complaints of backing away:

• The NASD attributes the upsurge in backing-away complaints to a protest by a small group of market makers angry that the NASD cut into their living in January by sharply limiting Nasdaq’s small-order execution system (known as SOES), which had been the basis for these firms’ profits. The NASD says the firms abused SOES, unfairly using it to take advantage of big market makers who were not fast enough in updating their prices. Indeed, a prodigious 85% of the complaints through late June were filed by a single small firm that heavily used SOES, Datek Securities of Staten Island, N.Y., the NASD says.

Not to get too nostalgic, but most if not all NASDAQ market makers considered Datek and other firms like them to be some very bad hombres. So bad in fact that they are better known as the “SOES Bandits” because of their consistent exploitation of NASDAQ’s Small Order Execution System.

The US corporate bond market does not have SOES Bandits, but to believe that every liquidity taker has the best intentions when executing a trade is naïve. So let’s step back for a moment and review what exactly is being asked of corporate bond market makers by vendors that want to create an order-driven institutional trading platform:

• Provide live and executable prices on screen for material size
• When someone engages you, complete the trade without knowing the counterparty
• Never back away from the trade

While the dream of a live executable order book may be a lovely thought for some, the reality for a participating dealer is a nightmare where they are consistently negatively selected and unable to build meaningful bi-lateral relationships with the buy-side.

Making Institutional Markets Real

Anyone who believes that live institutional corporate bond markets are right around the corner is not considering the perspective of the sell side in their vision of market evolution. It will take years of incremental development in areas outside of electronic trading technology to foster an environment where dealers feel comfortable providing order-drive markets. BondCliQ is building a system that has the key requirements for improving the quality and reliability of institutional prices. Our platform allows dealers to see the same pricing information as buy-side institutions, so they always know the position of their market. We encourage bi-lateral, fully disclosed engagement between clients and dealers through attributed pricing with visible performance rankings. Finally, BondCliQ allows dealers to make their own decisions on engagement and does not force a market maker to trade electronically. With this approach, executable institutional markets can organically develop as a by-product of competition for high-quality customer order flow.  -Chris White (CEO – BondCliQ)

A Better Corporate Bond Market: Human Beings Required

Sci-Fi books and movies provide a glimpse into the potential future, but there are two different approaches. Some project an existence where

computers and technology play a dominant role in almost every aspect of life, creating a world that is unrecognizable from what we know today. Things are neat, clean, and simple because robots and push-button solutions take care of everything from food to travel.

The other type of sci-fi presents a world that is complicated by innovation. While new technology provides benefits, it also creates new problems and dilemmas that require human intervention to solve. Given what we’ve seen in the last 35 years, the more complicated version of the future is far more plausible.

Late last week, a Bloomberg article discussed the potential for technology to “replace traders with algorithms and replace salespeople with APIs.” The goal of this effort is to move big corporate bond trades from the phone and chat to a screen, just like trading in stocks, currencies, and futures. This is not the first article of its kind, but typical of a widely held view that “going electronic” is the panacea for bond liquidity. Those that evangelize this idea often do so while omitting critical details about the real impact of electronic trading on financial market structure. Instead, we are presented with a neat, clean, corporate bond market of the future that requires little to no human support. The real story on electronic trading in financial markets is far more complicated.

Blockbuster

One undeniable fact is that electronic trading does not solve block liquidity issues. That is not to say that a block can’t trade electronically; they do, just not in block sizes. This chart tells the real story:

Removing a salesperson from the trading process has an obvious consequence: minimizing transaction sizes. Why? Because when you attempt to trade large size electronically, the market moves away from you. Without the ability to bi-laterally negotiate a block trade with a human being, buy-side institutions must break down their block orders into micro-lots to hopefully avoid detection on electronic platforms.

Swimming with Sharks

Another key aspect of electronic trading that is never mentioned in the discussion on the future of corporate bond markets is the predatory environment that follows “going electronic.” Here is a description of how equity markets have reacted to buy-side algorithms that are used for block trading:

“Buy-side firms use algorithmic trading systems to break up large orders into much smaller ones and feed them steadily into the market so as to reduce the market impact of large orders. In order to detect the presence of such large orders, HFT firms place bids and offer in 100-share lots for every listed stock.

Once a firm gets a “ping” (i.e. the HFT’s small order is executed) or series of pings that alerts the HFT to the presence of a large buy-side order, it may engage in a predatory trading activity that ensures it a nearly risk-free profit at the expense of the buy-sider, who will end up receiving an unfavorable price for its large order. Pinging has been likened to “baiting” by some influential market players since its sole purpose is to lure institutions with large orders to reveal their hand.” – Understanding HFT Terminology

Easy-E

According to the Bloomberg article, “Thirty percent of all bond trades are electronic, an all-time high.” FINRA does not track or publish pure electronic trading volumes for corporate bonds, so this may be more of an opinion than a factual statement. Missing from this and other declarations of corporate bond electronic growth are the details. What, exactly is trading electronically? We do not see the details because the true e-trading narrative may not be as exciting as we’ve been led to believe. What if a large percentage of corporate bond e-trading volumes were comprised of recently issued bonds and short duration (<7 years) investment-grade paper? These areas of the market have historically not had liquidity issues, so the net impact of electronic trading could be improving execution efficiency in bonds that are easy to trade while freeing up human traders to focus on more difficult, higher value transactions

A quick examination of the highly electronic US options market illustrates that very few contracts make up most market volumes. In fact, the NYSE reported that options on SPY accounted for nearly 20% of options volume for 2018.

The efficiencies achieved through electronic trading have major benefits to all market participants. However, evidence shows that these benefits can only be applied to areas of a financial market that have certain attributes (large float, good credit quality, known name). Algorithms and APIs can’t solve for execution for bonds that don’t have the same attributes, but humans can.

Faster isn’t better

While it is possible to trade institutional orders faster with electronic trading, we must ask if the efficiency gains offset the environmental consequences? For bonds with the right attributes, yes, but those bonds are a fraction of the broader universe of securities. If the goal of innovation is to improve trading conditions, then we must find the proper balance between humans, technology and data. Replacing one element (humans) and relying too heavily on another (technology) will not produce a healthy market environment. BondCliQ is contributing to the formation of a better market by improving the accuracy, reliability and access to pre-trade institutional pricing information. This data immediately helps human beings make better trading decisions and supports the development of more electronic trading. The right future for the corporate bond market is one where both humans and technology live long and prosper.

-Chris White (CEO – BondCliQ)

The Comment Section

Earlier this month, FINRA called for comment letters on the current proposal to delay TRACE reporting for large corporate bond trades. If you are an avid fan of market structure debates and really into bond market data, the 20 plus comment letters make for very entertaining reading. However, for some, reading every individual comment letter might be slightly less captivating. No worries, our blog post this month is dedicated to highlighting the key points that question the logic of removing key information from the corporate bond market. Before we begin, we’d like to acknowledge one submission in particular, Descartes Trading:

Boss move Henri. Respect!

Make the Markets Great Again!

The catalyst for the suggested TRACE delay is the undeniable fact that US corporate bond markets have experienced a pro-longed period of illiquidity. This problem could manifest into a material issue if meaningul volatility were to return to the market. Just last week, IOSCO published “Liquidity in Corporate Bond Markets Under Stressed Conditions” which is a 52-page ghost story on what could happen to trading conditions when rates normalize. To prevent massive dislocations due to illiquidity, some believe that removing transaction data from the market will…enhance liquidity? Regardless of your view on this idea, it is important to acknowledge the obvious link between TRACE and market innovation. The current US corporate bond market is unrecognizable from the pre-TRACE days almost 20 years ago. Since the introduction of centralized transaction data, we’ve seen the rapid growth and adoption of electronic trading, new products (ETFs, CDS, and CDX) and market data solutions. It is hard to imagine these evolutionary milestones occurring without the foundation of TRACE
information in place. Rolling back the reporting requirements could slow down the pace of innovation at a time when the market desperately needs new ideas to be great again.

Vanguard emphasizes this point very early on in their comment letter:

“Restricting market participants from acquiring current transaction information will also hinder the evolution and electronification of the corporate bond market. Post-trade transparency serves as a foundational building block to foster technological changes and innovation in the fixed income markets. Information obtained through post-trade transparency will increasingly facilitate liquidity as fixed income markets evolve from principal-based market making to agency and electronic market structures.”

The Price Is?

Every day the institutional bond market participants must assign a value to individual positions with notional sizes in the millions. This process is a requirement for actively managed portfolios, passively managed index products (ETFs) and inventory held by dealers. Accuracy of portfolio
valuations and risk analytics depends on complete information about prices and transactions. Healthy Markets Association did an excellent job of articulating this point in their comment letter and includes supporting comments from FINRA for good measure:

“Loss of Price References for Market Participants.

Most market participants would lose an incredibly valuable reference point–not just for the security traded, but for similarly situated securities. This could impact evaluative pricing tools, such as those offered by third parties, and relied upon by many market participants – not just in the pricing those specific bonds but other bonds where those prices are used in evaluating fair values. Put simply, all investors other than the dealer involved in the trade would not be aware of the important reference point. This could lead to executions for retail and other institutional investors at materially worse prices. Further, this loss of a reference price may materially impact a number of other financial products, such as bond-based ETFs.

As the FINRA Proposal notes:

The impact of delayed reporting may well have an amplified effect on securities deriving their value from corporate bonds. The impact could lead to less efficient pricing of index-based products, such as ETFs, and derivatives, such as total return and credit default swaps. If the pilot makes it more difficult to mark-to-market the relevant securities, market participants, who do not trade blocks benefitting from delayed reporting dissemination, may be more likely to use stale prices for operational and accounting purposes.

We agree with this significant concern. The data reflects that as much as 50.5% of those block trades occur in bonds that are included in at least one of the seven largest fixed income ETFs. This is a significant concern for investors and market makers in those ETFs.”

Just the Facts Ma’am

Pushing a pilot program for testing a theory on market structure is no small feat. It requires the formation of a problem. The suggestion of an idea to solve said problem. Then, most importantly, evidence that supports the theory behind the suggested solution. If you’ve been paying attention to the FIMSAC discussions regarding the TRACEs delay, a key argument against the pilot has been the lack of evidence that removing transaction data would help trading conditions.

Citadel smashes this point home like an overhead lob:

“…to the extent there has been any deterioration in block trade liquidity, there is no evidence to suggest that it is due to the current post-trade transparency framework. In contrast, academic research has found that post-trade transparency has improved corporate bond liquidity and has reduced transaction costs. Post-trade transparency has benefited not only retail investors, but also institutional investors transacting in larger size. In particular, academic research has found that posttrade transparency has caused “trading costs to decline significantly for the entire bond market” and has even improved liquidity conditions for block trades, directly contradicting the claims made by those supporting the Proposed Pilot. Specifically, an analysis of the institutional 144A corporate bond market found that the introduction of posttrade transparency in 2014 significantly reduced transaction costs for block trades, with the largest reductions observed for blocks that exceed $25 million in size. In addition, there was no evidence that post-trade transparency reduced block trading volume or otherwise impeded the ability of market participants to execute blocks, or reduced dealers’ willingness to hold inventory. In fact, overall trading volume of large blocks increased following the introduction of post-trade transparency. FIMSAC did not appear to consider the academic research above as part of its deliberations. Moreover, FIMSAC did not explain why it narrowly focused on suggesting changes to the post-trade transparency framework, as opposed to considering other aspects of market structure that can impact liquidity conditions, such as  regulatory capital requirements, the ongoing transition to electronic trading, the observed increase in agency/riskless principal trading, and liquidity dynamics in hedging instruments, such as single-name credit default swaps. Ultimately, neither FIMSAC nor FINRA were able to identify any academic research supporting the suggestion that reducing post-trade transparency can be expected to improve liquidity conditions for block trades. As a result, the asserted benefits of the Proposed Pilot appear to be unsubstantiated and illusory.”

Trust Me

When designing a trading platform, a virtual market place or even a board game, the rules and protocols cannot be susceptible to manipulation. Any product development person will tell you that a critical part of their process is thinking about behaviors that could “game” the system and coming up with techniques to eliminate those activities. Failure to account for opportunism will ultimately cultivate opportunism, especially in situations where the stakes are high. There is a long history in financial markets of ideas that were intended to enhance market quality, but ended up deteriorating market integrity (cough…SOES…cough…Bandits).

A two-tiered information disemmination structure creates countless scenarios for manipulation, but MIT Management provided a hypothetical, but plausible scenario in their letter.

“Delayed dissemination of trades may also lead to legal and systemic risks in times of stress and uncertainty. Suppose, hypothetically, an issuer faces imminent default, but only market participants close to the firm are informed of this likely event. The transaction prices between those sophisticated investors on the firm’s bonds will reflect the imminent default risk. But if TRACE delays the dissemination of price information, smaller and less sophisticated investors may end up paying for the bonds at higher prices, which they would not pay if TRACE had reported the transaction prices in real time. In this case, those small and less sophisticated investors are materially harmed by the delayed transaction reporting and may rightly resort to legal actions against FINRA. Worse still, if the defaulter in this hypothetical scenario is a systemically important financial institution, suppressing transaction prices of its bonds could even increase systemic risk.”

Need to Know Basis

Need to Know Basis We’ve written about transparency in a previous blog post (A Fear and Loathing of Transparency) and believe that transparency is a fundamental requirement for market innovation. However, to extract the benefits of transparency while avoiding the potential negative consequences, appropriate protocols around visibility and access are needed. With regards to TRACE information, a key question we have for FINRA and both sides of the current debate is this: Why do size details need to be visible at all? Replacing the size details with a standard indication of <$500k or >=$500k would address the concerns of those who believe transparency is hurting liquidity while maintaining equal access to critical transaction data.

For BondCliQ, we use a unique protocol approach to generate high-quality institutuional pricing data. Our system gives participating dealers access to essential pre-trade data while protecting their proprietary information. Maintaining this balance allows the data to get better over time and fosters an environment where transparency and innovation can lead to better liquidity conditions for all.

-Chris White (CEO – BondCliQ)

Size Matters

While the future state of the US corporate bond market is a topic of constant debate, there is universal agreement that the market has changed. Relative to 20 years ago, the most visible difference in structure is the sheer size of the outstanding market. Discussing the rapid growth of the corporate bond market is not new, but the details of this expansion are profoundly and permanently altering the environment. An in-depth examination of how the US corporate bond market has grown is essential for predicting which new ideas will help participants adapt.

Deja Vu

Revisionist history tells us that one of the key catalysts for the 2008 market meltdown was the lack of lending standards for individual borrowers. NINJA loans and no-asset mortgages are relics of a time when we were not as wise about the potential consequences of easy money…right? Well, it hasn’t taken long for history to repeat itself. Just replace “individual borrowers” with “corporations,” and similar conditions that precipitated the crisis are currently in motion. The recent outstanding performance of both the stock and bond markets are diverting our attention, but this sobering quote from Bill Gross in 2012 is highly relevant today: “They would have you believe that stocks, bonds and real estate move higher because of their wisdom, when in fact, prices float on an ocean of credit, a sea in which all fish and mammals are now increasingly at risk because of high debt and its de-levering consequences.

Low End Theory

As a result of central banks continued quantitative easing policies, it has never been easier for public companies to issue bonds with extremely low yields. Of course, just like the sub-prime crisis, the least qualified borrowers have been taking full advantage of this situation and yield-starved investors have no choice. Last year’s WeWork deal provides the perfect illustration of this conundrum:

“This week high-yield bond investors faced a puzzle: how to value a bond sold by an unprofitable company that does not own hard assets or offer a clear outlook for its free cash flow? The company in question was WeWork, the office-sharing company that last year attracted a $4.4bn equity investment from Japan’s Softbank. WeWork, which hired JPMorgan to lead the sale but had more than a dozen other banks working as well, attracted enough demand to increase the sale to $702m from $500m.”

The current “ocean of credit” has created a corporate bond market that has never been more dangerous. While the true risks have yet to fully manifest into losses, investors are not being compensated properly for lending to hazardous companies. This is the equivalent to picking up quarters in front of a steam roller. It only takes one misstep (a default)to flatten your entire portfolio (buy-side) or your balance sheet (sell-side).

Attack of the Killer B’s

Any new idea in the US corporate bond market must address the growing population of BBB bonds that now dominate the landscape. By definition, these bonds are on the border of the investment grade universe. A bad quarter (or two) and a BBB issuer can find themselves reclassified as high-yield. Given these mechanics, many BBB bonds trade very differently than higher-rated issues. Transactions are less frequent, electronic trading is more difficult and market data (pricing and transaction information) is at a premium.

Corporate Bond Darwinism

Sophisticated buy-side institutions have been consistent in their demand for new solutions that allow them to adapt to the corporate bond market. While the initial requests were for more electronic trading tools, interests have shifted to data-focused tools like Algomi ALFA or the augmentation of their traditional OMS platform. In the short term, early adoption of market data solutions have provided buy-side institutions with a material edge over market markers: “By aggregating formerly separate pockets of market data into one single interface ALFA enables the trader to instantly see the price of a security before engaging in a trade allowing us to be price makers rather than price takers. We are also mining data from this and sending it to quants who can look at a huge range of findings on cost and spread analyses, such as future new issue concessions and liquidity cost scores.” This imbalance in information has led many to believe that well informed buy-side institutions will be the new liquidity providers in the market. I think this view is misplaced, but my thoughts are covered pretty well in an earlier blog. A more probable scenario is that instead of being replaced by buy-side institutions, the surviving dealers catch up and begin to leverage improved data as well.

Dealer Adaptation

The traditional approach to building a corporate bond dealing franchise could be loosely described as “building market share.” This process involves printing enough trades to be viewed as “the market” in a sector, complex or individual issuer. In theory, successful implementation of this strategy will allow a dealer to profit over time by getting exclusive access to client order flow. A riskier market combined with constrained balance sheets and less time to hold inventory may have rendered the market share approach obsolete. Not all corporate bond dealers have remained committed to this strategy, so many are trying new ideas like algorithmic trading, direct electronic trading feeds with clients, increasing agency trading activity or ETF market making. No matter the path, for a corporate bond dealer to successfully adapt to today’s market, they need access to better market data. Unfortunately, despite originating the invaluable pricing data that has become essential to any market, dealers are forced to buy their own data back from vendors that aggregate their pricing information. As a result, yet another line item is added to the operating costs of a corporate bond dealer. BondCliQ breaks this structure by allowing dealers to access the institutional pricing information that they collectively create and proactively improve it over time. Now dealers can adapt to the BBB-dominant market like buy-side institutions and “see the price of a security before engaging in a trade.”

Looking before you step may be the most important thing to do in a market full of potential land mines.
-Chris White (CEO – BondCliQ)

Fear and Loathing of Transparency

In any given market, there are fears that shape and mold the behavior of the participants. Except for red pens on the trading floor, most fears are unwarranted and dissipate over time due to evolving perspectives. The transformation phase can take years or even decades, but in the end there is often a crescendo of debate before a given fear is permanently cast out. For the US corporate bond market, the recent FINRA request for comment regarding a pilot program to delay block trade reporting may be a sign that this market is reaching an apex in the argument about transparency.

The Breakdown

Here is a brief synopsis of the current state of trade reporting: Since 2002, the US corporate bond market has had trade reporting via ‘TRACE.‘ Throughout the years, TRACE has matured to provide timely reporting (within 15 minutes) of all dollar-denominated trades for US corporate bonds. If the size of a high-yield corporate bond trade is >= $1MM, TRACE will display a capped +$1MM size indication. If the size of a high-grade corporate bond trade is >=$5MM, TRACE will display a capped +$5MM size indication.
FIMSAC has proposed to increase the transaction reporting caps to $5MM (HY) and $10MM(IG) and delay the reporting of trades that exceed the new caps by a full 48 hours. In the coming weeks, there will be plenty of opinions expressed that support or condemn the proposed delay. However, at the core of this disagreement is a fundamental question that needs greater focus: Why are some corporate bond market participants so afraid of transparency?

We have nothing to fear but transparency itself!

Outside of the bond market, the world appears to benefit from transparency. Knowing the ingredients on a package of food, the calories for a meal, or the cleanliness of a restaurant can save your life, keep you fit or prevent a horrible night of indigestion. Transparency in markets is more complex because of this universally viable concern: Available information about my past behavior, current position, or future intentions will have an adverse impact on my trading activity.

To avoid the negative effects of transparency, market participants adapt by routinely omitting information and distorting the truth. Before rushing to judgment on these deceptive practices it must be acknowledged that this behavior is quite normal and observed in almost every market. For example, if you are selling your house, do you tell the first potential buyer that they are the first and only interested party? No! You tell them that they are one of many people interested in purchasing your home. Doing so masks the true level of demand, which helps to preserve your asking price.
This is exactly the intention of the proposed 48-hour delay for block trades. Mask the true level of supply or demand in the market to prevent pricing from destabilizing when there are large transactions. Unfortunately, removing transaction information from a marketplace will lead to a smaller network for trading because less information will discourage broad participation, undoubtedly hurting liquidity in the long run. Using our real-estate example, you would receive fewer inquiries for purchasing your home if there was no available information regarding the transaction prices of similar properties in your location. Furthermore, the initial act of setting the price would be impeded by the lack of transaction data.
Extracting the benefits of transparency while eliminating its detrimental effects requires techniques that are normally reserved for electronic trading platforms. To get the best out of transparency, we need protocols. Applied properly, the right transparency protocols will increase access to information while protecting the proprietary data that can destabilize a market. Regrettably, mandated transparency initiatives rarely include anything but basic protocols that are universally applied to all market participants. As a result, transparency has historically brought unintended negative consequences that reinforce the fear of information.

Data is the New Oil

As other modernized markets have shown, making basic transaction and pricing information available to all market participants is a fundamental requirement for innovation. Due to the idiosyncratic nature of the institutional US corporate bond market, a standard approach to increasing transparency is sub-optimal. We believe that leveraging the positive benefits of transparency is directly predicated on rules and protocols. BondCliQ generates high-quality institutional pricing information by implementing unique protocols that improve access to data while appropriately socializing proprietary information and limiting the exposure of the dealer. As more market participants use reliable pre-trade information to improve their trading decisions, risk management capabilities and market making performance, data will gradually be accepted as an invaluable commodity.
The institutions that get over their fear of transparency first will be the first to reap its benefits.
-Chris White (CEO – BondCliQ)

Why G-Sessions Failed?

New ideas are introduced with great fanfare and promotion, but rarely does a new solution survive to meet the expectations of the initial hype. Anyone who has been in the corporate bond market since 2000 knows that there is no shortage of failed initiatives to improve secondary trading. For one reason or ten, almost all these ideas did not work and were eventually shut down. What we don’t hear (unless the inventor is a good friend) are the details of what went wrong. This is very unfortunate because, as a market, how can we figure out what works without knowing what doesn’t. As the creator of GSessions, an idea that didn’t survive, I will and you this story of failure. Hopefully the account will not only provide insights into the mechanics of the corporate bond market, it may also stop people from randomly grabbing me at conferences and saying “hey, do you want to know why GSessions didn’t work?” So, gather round your monitor my friends and read this harrowing tale of poor assumptions and protocols gone wrong. (This is the made for TV version of this story, so all the rated-R scenes have been cut)

So,What’s the Big Idea?

The concept for GSessions was “borrowed” from the ITG Posit platform which was launched in 1987 as one of the first dark pools in the equity market. GSessions and Posit shared the same underlying theory, liquidity for complex trades (blocks) could be generated if you slowed down the market through scheduled trading.  Another word for this idea is “Temporal Consolidation” which is a fancy way of saying “let’s get everyone to trade the same thing at the same time”. Professor Robert Schwartz (NYU) is one of the pioneers of this theory and wrote an excellent paper on its benefits (Electronic Call Market Trading). The goal and promise of GSessions was to provide reliable institutional (block) liquidity in corporate bonds to clients at a lower cost, WHILE reducing overall risk to the trading desk. Sounds great, but how? GSessions’ workflow was designed to get as many clients to trade at the same time as possible:

• Goldman’s trading desk would pre-announce sessions for a group of individual CUSIPs
• Announcements declared the trading session time and the amount of guaranteed liquidity
• When a session started, clients were presented with a two-sided market for each bond
• For 5 minutes, the GSession platform would collect orders, but there was no execution
• At the conclusion of the 5 minute period, all orders would be matched until the guaranteed liquidity threshold was met
• If there was not enough two-sided orders to meet the guarantee, Goldman would fill the imbalance

There are more details around order handling and visibility, but for the purpose of this story it is not important. The hope was that there would be enough consistent two-sided interest in a session to reduce the amount of capital committed by the trading desk.

Build It and They Will Come…Sometimes

If you have never been a part of an organization that is managing an electronic trading platform, launching a new system can be best described as throwing a party in high school…that is, if you were a person who was extremely awkward and self-conscious. You’ve sent the invitations, talked it up all over school, made a killer dance mix, but you have no idea if people will show up…now imagine going through that feeling every single day. That’s what it is like when you are trying to establish a new trading platform in the US corporate bond market.   

After the Love is Gone

For GSessions, clients showed up and traded for the first few weeks, maybe even months, but after a while, when the novelty wore off and all the favors were called in, things started to slow down. GSessions stopped attracting consistent order flow from clients, which sparked a host of theories as to what was going wrong. 

Maybe they don’t like the ‘G’ in GSessions

By far this is THE most popular opinion on why GSessions ultimately didn’t work (both internally and externally). The theory is that clients liked the protocols but were uncomfortable with the fact that Goldman was the center of each trade and had access to their order information. In anticipation of this skepticism, we had protocols in place to protect customer identities and froze all trading of the issue during a session, but there was still a “trust us” factor to GSessions that was not ideal. To further complicate matters, there was a certain Op-Ed in the NY Times that really did not help the cause. Let me tell you my friends, if you’ve never pitched a new dark pool trading system to a client who thinks you and your colleagues routinely call them ‘muppets’ behind their back, you have not lived! There is no doubt about it, aversion to a single-dealer trading solution was a factor in why the GSessions platform failed, but I don’t think it was the biggest obstacle.

I want Liquidity and I want it NOW!

Even if GSessions could consistently deliver on the promise of reliable institutional corporate bond liquidity at better prices, there was an inherent trade off, buy-side clients would have to wait to trade. This required change in behavior was NOT a small request. Buy-side institutions are used to being able to transact what they want, when they want, so GSessions would have to consistently demonstrate liquidity and cost benefits that would outweigh the sacrifice. It didn’t. So it is safe to say that scheduled trading was certainly an obstacle to success, but I think this could be characterized as an undesirable feature, and not a fatal flaw.

Is Next..Day Wear..Is Next..Evening Wear..Is Next..Swim Wear

Despite being a single dealer system and having timed trading sessions, there remained a loyal group of buy-side clients that believed GSessions could work. Unfortunately, they gradually began to lose faith in the platform due to bond selection. Clients asked for sessions in off-the-run, illiquid bonds, but traders were unwilling to offer those bonds via GSessions and instead stuck to benchmark issues which could be traded at any time off platform. This lack of variety dramatically reduced the utility of the platform and eventually brought GSessions into the new idea graveyard.

As this digital autopsy indicates, the most likely cause of death to GSessions was a combination of these three major obstacles. Personally, the experience gained from trying and failing was invaluable and completely changed my perspective on corporate bond market structure…for the better.

E-Trading is NOT the panacea for the corporate bond market

For the past 10 years the US corporate bond market has looked to electronic trading as the key component to build a better market with ample liquidity. This is a logical assumption based on the preponderance of e-Trading in more “evolved” markets. We believe that the true foundation for developing well-functioning markets, for both voice and electronic trading, is reliable data. BondCliQ is specifically designed to centralize invaluable institutional prices and improve the quality and accuracy of pre-trade data over time. As history indicates. once pricing information is organized and made available in a given market, liquidity conditions dramatically improve because there are more trading opportunities across a greater universe of securities involving a larger community of market participants. Electronic Trading has had over a decade to resolve the material structural questions being asked by the US corporate bond market. It is time to change the answers.

-Chris White (CEO – BondCliQ)

This is a bit personal, but for a very long time I absolutely, positively believed in Bigfoot. Looking back, I blame my favorite

uncle’s sense of humor for convincing me that Bigfoot was roaming somewhere in the forests of Huntington Long Island, just waiting to grab my cousins and me. Eventually a pivotal question completely shifted my view on the existence of Bigfoot: If Bigfoot exists, why haven’t we found ANY bones? However, this is not the case for a large population of Bigfoot enthusiasts who hold fast to the belief that this creature exists even though “there has never been any real biological evidence, like bodies, bones, skin, hairs, or DNA found.”

The concept of Buy-Side Liquidity is the “Bigfoot” of financial market structure. There has never been any statistical evidence that buy-side to buy-side trading can create meaningful liquidity in any financial market…ever…in the entire history of financial markets. However, this idea is consistently raised as the ingredient for a better corporate bond market and continues to spawn new ideas for trading solutions that remove intermediaries (dealers) from the trading process. On the surface, it is logica

l to assume that buy-side to buy-side trading can generate reliable liquidity. Based on the numbers, as the size of the corporate bond market has increased, so has the ownership share of asset managers. If the buy side holds the bonds, why can’t they just trade with each other?

The answer can be found in the breakdown of a typical asset manager’s workflow. For a buy-side to buy-side trade to happen, Asset Manager ABC must have a standing order to sell a specific CUSIP within the same time period that Asset Manager XYZ has a standing order to buy that same CUSIP. The critical catalyst to any potential buy-side to buy-side trade is that one asset manager must have a redemption or need/want to change their portfolio composition while the other has an inflow (cash) or the opposite need/want to change their portfolio composition at the same time. This restriction is what makes Buy-Side Liquidity impractical and unreliable for consistent trading. The asset manger’s first, second, and third priority is to serve their customer, not the trading needs of another buy-side institution. Ultimately, we will be consistently led to the same conclusion: Intermediaries (dealers) will always be an essential ingredient to a well-functioning market.

True-believers will hold on to the notion that a large network combined with the right type of trading protocols will yield the hard evidence of the existence of meaningful Buy-Sde Liquidity in the corporate bond market. Thankfully, over the past seven years, the largest corporate bond trading network in the world, MarketAxess, has been diligently working to produce ample Buy-Side Liquidity through their Open Trading solution. An exchange during the most recent MarketAxess earnings call (Q4 2018) provides insight into the state of buy-side liquidity:

ANALYST QUESTION: Okay. Sounds good. And then in Open Trading, I guess, the percentage of Open Trading today that’s buy side to buy side, I know it’s a pretty small percentage, but any color there and trends?

ANSWER RICHARD M. McVEY: I wouldn’t call it (buy-side to buy-side trading) small, it’s – as there has been in past calls, there are the three main pools of liquidity that are coming through Open Trading; the alternative market makers, the expanded dealer community participating in orders and then the buy side. But the trends have been pretty stable in terms of buy side participation in Open Trading liquidity provision and it’s an still important source that – it’s running around a quarter of the volume that is done on the system.

Translation: Despite the network, the technology, and the resources of MarketAxess, 75% of Open Trading volume is generated by the dealers (not sure who counts as an alternative market maker). Furthermore, the 25% of Open Trading volume that does come from buy-side to buy-side trading is approximately $370mm in daily volume, or 1.3% of overall market volumes (this is using MarketAxess data). Organic liquidity is a definite positive, but at the margin, is this the optimal way to create material liquidity in the US corporate bond market?

To Improve Liquidity We Need Improved Liquidity Providers

We believe that the only proven method to meaningfully increase liquidity for the buy-side is to increase the liquidity capacity of market makers. Therefore, the BondCliQ approach to improving the US corporate bond market is quite different than other initiatives. We are not designed to replace the dealers or diminish their role in the market. In contrast, BondCliQ helps dealers leverage the invaluable institutional pricing information that they collectively create. By incorporating pre-trade data into their market making process, dealers will be able to provide block liquidity to their customers with more confidence. In the coming months, it will be interesting to see how fast dealers adapt to this new data set and the positive impact it will have on the quality of institutional pricing and liquidity for asset managers.

In the meantime, I look forward to the next Bigfoot sighting that somehow missed being recorded or new wave buy-side liquidity solution that will change the world but has no actual details.

-Chris White (CEO – BondCliQ)

A few weeks ago, BondCliQ launched the first consolidated quote system for the US corporate bond market. This is just another step on a journey that has required over three years of hard work but it feels great to transition from concept to product. For some time now, institutional market participants have been searching in earnest for the tools that will help them adapt to a market that looks quite different than 10 years ago. This demand has created a period of rapid innovation, with many new ideas and platforms. The amount of effort it takes an organization to meaningfully evaluate an individual vendor is non-trivial. Therefore, as a new solution provider, we intend to make your assessment process easier by clearly and consistently articulating our approach to improving the US corporate bond market through our monthly blog post (A BondCliQ View). This post will touch on just a few topics, but there will be many more to come. Your feedback, criticisms, thoughts, and of course, encouragement are welcome. Feel free to comment openly or directly to me (chris@bondcliq.com).

Platforms Are Consolidating? Really? 

Every new year brings with it a slew of predictions about the trends that will dominate the next 12 months. For the US corporatebond market, this process involves a slew of articles, opinion pieces, and research meant to identify the coming trends that will change the market. One prediction for 2019 really caught my attention: Corporate Bond Trading Platforms Are Going to Face Consolidation. There are several interesting components to this perspective, the first of which is the underlying thesis that customers aren’t interested in having to connect with multiple platforms. There is a nuance here that needs greater attention. Despite an abundance of FIX API feeds from individual platforms, there is no “out of the box” solution in the US corporate bond market that provides seamless connectivity across all platforms, so customers are rightfully daunted by the prospect of doing it themselves. Perhaps this fear is being misinterpreted as a lack of interest in new platforms, but I doubt it. If there was less friction to combining multiple platforms, market participants would absolutely welcome more electronic liquidity pools. This is especially the case for the corporate bond market makers who are most negatively impacted by the lack of competition in the electronic trading space.

The next component of the platform consolidation prediction is that fewer solutions would provide better liquidity and data in thelong run. There is history here that needs to be referenced because this exact debate was held in the US equity market about 50 years ago. At that time, the future of the market was in doubt because of a persistent lack of institutional liquidity (sounds familiar no?). The argument was whether a regulated monopoly (NYSE) or free competition would lead to a better secondary trading environment. Free competition won because, in the long run, most people believed that a monopoly solution would create greater systemic risks with higher transaction costs. Ultimately, the free competition supporters have been proven right. Electronic trading costs in the US equity market have never been lower and when there is an outage at any exchange, even the NYSE, the market keeps trading without a hitch. Meanwhile, the recent technology glitch at BrokerTec provides a preview of what could happen if the US corporate bond market adopts a monopoly solution approach.

Collaboration beats Consolidation

The BondCliQ approach to improving the US corporate bond market is to collaborate with other service providers to create transformative solutions. We view our centralized, institutional pricing data and data visualization application, BondTiQ, as being components of a better market. Our products are designed to be interoperable with electronic trading systems, EMS providers, OMS providers, and evaluated pricing services, so end-users and vendors can benefit from greater access to high-quality pricing data. We believe in the vision articulated by desktop operating systems like OpenFin and Finsemble and further echoed by platforms like Algomi that combining best-in-class solutions is the ideal model for the end user. Therefore, my prediction for 2019 is that the desktop experience for US corporate bond market data and analytics will materially advance, while the user experience for electronic trading will remain stagnant due to lack of collaborative solutions.

Competition and collaboration are the yeast in the dough of innovation. Without it, US corporate bond market participants will be very disappointed with what comes out of the oven in the next few years…ok, now I’ve made myself hungry.

-Chris White (CEO – BondCliQ)