Bond liquidity drought: Sourcing without showing your hand
The corporate bond market is worth $10tn, partly as result of having doubled in the past decade as low interest rates have swelled investment.
Some of the largest bond deals in history happened in 2015, yet corporate bonds are in the centre of a bond liquidity drought in trading in the secondary markets, particularly as banks have had to cut their holdings. The Bank of England reports that since 2008, there has been a 75% reduction in bond inventories of dealers in the market.
But despite a liquidity drought occurring, the investment firms, fund managers, pension funds and asset managers still need to identify reliable sources for their corporate bonds. They also need this information without anyone knowing that they’re looking; conscious that by following up on attractive bond prospects, they are indicating their own interest in an instrument and other market participants might start sourcing the instrument themselves, potentially increasing the final price for the investment firm. Both these things were ringing in everyone’s ears in 2015.
Trouble is, traditional methods of obtaining such information are static and incomplete. Data is very often presented in different formats and some of it is so voluminous that advanced search tools have been built in an attempt to enable investment firms find the security they want. Some buy-side investors have reported receiving 30,000 messages a day of data, leaving investors with significant data overload. More importantly, the quality of this data varies so much that asset managers are unable to rely on it.
Together, regulation, collaboration and technology just may be drivers for change. In the regulatory space in Europe, MiFID II is increasing the focus on pre-trade information and transparency. ESMA is beginning the collection of data to support the various thresholds and tests they will implement when MiFID II comes into force. For investors, this transparency will make available another stream of pre-trade data that will further inform the investment and trading process. Depending on the implementation, MiFID II creates the opportunity of ‘actionable RFQs’ where quotes are published as a ‘hittable’ price for a limited period and audience.
How the implementation of these regulations might affect the market is difficult to determine. The intention is to improve liquidity – improving the distribution of prices and associated pre-trade information should, in theory, lower the cost of trading and enable investment firms to improve the efficiency of their trading activity. The next three years will see the market impact of these initiatives play out for all to see.
As well as regulation, businesses can drive change as they continue to identify their own strengths and weaknesses and isolate competitive areas from those that are common across the market. By collaborating and adopting standardisation when useful, this will increasingly bear fruit and benefit the market as a whole.
Technology is itself also constantly presenting new potential opportunities – block-chain, social media, big data and crowdsourcing to name a few – that might provide some solutions. Initiatives like Neptune, the open standards network utility for electronic pre-trade indications in bond markets, for example, will help address the question of invisible inquiry by using its commoditized technical components. The technological ease of the system allows for seamless integration in existing systems. Continuing to expand, this automated utility model allows banks to send point-to-point high quality, structured pre-trade information to their individual clients in real time. It is this quality that will allow investors to fit their investment decisions to availability in the market.
Run by a consortium of sell-side and buy-side and using the open standard FIX Best Practice for delivering pre-trade information using a robust data governance model, the Neptune network is solely focused on commoditizing the technology layer to enable standardised communication of pre-trade data. The sell-side involved in the Neptune Collaboration are now sending pre-trade indications to their clients across the Neptune network to which the asset managers are connected directly via any combination of the Neptune GUI, an internal or external OMS. A truly collaborative effort between the buy-side and sell-side, it is evidence that market participants can come together to create fair and efficient markets and is a step in the right direction towards increasing velocity and liquidity in the bond markets.
Neptune is now extending the fixed income pre-trade information network to the global financial community. With over $16bn of gross notional and nearly six thousand line items, referencing over four thousand ISIN’s across IG/HY/EM bonds, the platform is fast expanding from its initial focus of purely European IG/HY corporate bonds, to a portfolio that also reflects the global nature and reach of its user base.
One thing for sure, 2016 will be an interesting year for corporate bonds as the industry finds new ways to solve the challenges 2015 brought, and it is highly likely that efficiency and transparency will be at the top of everyone’s priority list.
Kuhan Tharmananthar is product manager at Etrading Software