Before I get started on my rant about Credit e-trading in Europe, can I please state two things:
1) Categorically I am a believer in credit for Fixed Income! Corporate Bonds, Subordinated debt, MBS, ABS, CDO, CLNs, FRNs (I don’t think of Supras, Agencies, Pfanbriefe etc as Credit in this context)….I believe, I truly do. Whether the spreads are far too narrow in relation to the risk is another matter and not for a blog on e-trading.
2) e-trading for Credit in Europe works for retail flow. Bloomberg do a great job of executing these essentially very simple trades, Reuters not quite as good a job,……because it is all about the price/yield the less than sophisticated end user wants. It is all about getting a massive number of small tickets done as efficiently as possible.
Now to the crux of this piece: E-trading for Institutional Sized Cash Credit in Europe has Failed.
You all agree? No? Is it only Market Axess & those at TradeWeb who joined for the Corporate offer that disagree? Or maybe the handful of institutional clients across Europe that do anything resembling a material % of their trades (not necessarily volume) electronically?
It is debatable as to whether it has failed or is failing. I prefer to be a bit more definite as I think the future doesn’t hold great hopes for the development of cash credit bonds electronically.
Liquidity is poor, for mostly obvious reasons, and getting worse – note the huge amount of M&A work that is being financed by various complex loan arrangements rather than bond or equity issuance. 2006 looks like being a very sad year for new corporate issuance….but have no fear bankers, your M&A guys have more than made up for it! As we all know, Liquidity is vital for a product to be sucessfully supported electronically.
The structure of the market isn’t conducive to e-trading. By this I mean the way institutions trade, spread vs. swap, spread vs. govt etc and of course the ovious fact that you have so many issues by so many different issuers with each issue often having a limted number of banks supporting it etc, thus rendering inventory as a major driver of liquidity. This is stating the obvious and yet many ECN’s continue to try and ram corporate bonds down people’s throat electronically, whilst essentially following the government bond model of CRFQ & trading on price.
The likes of Market Axess & now TradeWeb have clearly focused on the institutional side of credit. However MA have never been a raging success in Europe (The US is very different given the deeper and more mature credit market there) whilst the TradeWeb offering has been luke-warm at best – in fairness it is still early days, but I don’t see it really taking off.
Can the Banks & ECN’s do a better job to meet institutional needs in this space? The answer is yes, but I can’t see them replicating phone/block trades to a satifactory degree…..primarily because of the liquidity factor – so ECN’s can continue to blame the Price Makers!
In my opinion, the real death-knell will be when single-name CDS goes electronic…..within the next two years. Liquidity will be far better, hedge funds will be more involved. Corporate Bonds will remain as important as they are now, to institutional investors, but I just don’t see how they are traded, electronically, developing enough over the same period.
November 21, 2006 at 2:33 pm
[...] Just a thought in relation to waratahs post question regarding credit bonds here [...]
November 21, 2006 at 5:07 pm
Electronic markets work best when securities are uniform and trading is frequent so participants have easy references for setting prices. In the credit markets, particularly non-invesment grade, the proliferation of slightly different terms makes comparison and accurate pricing of any individual issue challenging. MA and Tradeweb can describe the issues accurately, but one is still left with infrequent trading in any individual credit instrument. Dealer have little incentive to post agressive prices because they will be picked off by hedge funds and have to carry inventory which they are loath to do. Indications on these electronic markets inevitably lead to phone call by buy side accounts and opportunities for desks to work orders prioir to making firm bids, minimizing inventory. Dealers today are in the flow business. Hedge funds are the real source of liquidity and much of their demand is price and timing sensitive so offering firm prices executable in real time is an improved workflow that improves market liquidity. There are initiatives in the planning stage that permit dealers to post executable markets to hedge funds electronically for several of the US credit markets. The dealers make the markets bilaterally and offer individual pricing to each customer. Hedge funds can work orders with individual dealers or initiate RFQs. When trades occur, they are recorded in a data base record that is made available to all participants in the system helping improve pricing transparency.
November 22, 2006 at 12:13 am
Will the new NYSE Bonds platform, approved by regulators last week, with transparent bid/ask be useful for Euro hedge funds? I assume they purchase some US names…I don’t know if they have built any connectivity to Euro markets other than through BBG.
The early trading session starts at 4:00 am ET…
November 22, 2006 at 11:16 am
Cate, not that familiar with the NYSE Bonds platform but by the look of it it may have a retail flavour. That has been sucessful in Europe & remains so, particularly via BBG. So not sure it could offer much for institutions. THeir is transparency in terms on bid/offer, just that the spread tens to be retail in width plus most instos want to trade on a spread to govt or swap, not price. Price will get sorted later.
November 22, 2006 at 10:22 pm
I agree with all your thoughts…the spread issue versus price is an interesting shortcoming in the NYSEB…maybe a vendor could repackage the NYSEB offerings off a benchmark… : ) for transactional delight…
The half spread of retail is estimated at 83 bp versus 11 bp for 100+ bonds corp trades on average in the US…imagine! such a big mushy oppurtunity…I’m sure the puzzle can be unwound of how to make $ in between the markets…
November 28, 2006 at 8:14 pm
Given the “onboarding” effort for each customer firm for CDS is enormous (is anyone routinely able to get a new firm on board in less than 2 months?) compared to bonds (where all dealers really should be able to turnaround a request in less than 24 hours if they prioritise it high enough), in terms of agreements credit and legal work as it stands it seems safe to say that CDS is never going to be an electronic product for the critical mass of “tail” clients.
Ah, so this then fragments (or perhaps more accurately “tiers”) the market in terms of products available – which may appear untidy and bad, but really should not be an issue. As you say there is a retail flavoured and widely available bond offering on Bloomberg and others. And of course maybe ETFs could one day leap to the rescue as a route for smaller investors to gain exposure via an exchange to particular sectors, segments, or whatever – so they dont even bother with credit bonds. And as all that “retail” stuff above settles T+not-very-many, as opposed to having to commit resource for years to service those open [CDS] agreements, every ones a winner!
So this leaves the institutional guys (including hedge funds) to focus on structured product in the credit space; something where the banks can really tailor the product to provide maximum yield and/or to hedge a very specific liability. There really should already be appetite on client side to maximise the value you get from your sellside counterparts, and equivalent focus in the sellside to please their strategic clients with clever products, so perhaps its “just” the hurdle of the funds getting their mandate to trade in the murky world of “derivatives”?
So once the funds can trade these, why would you not want to “trade it” (agree it) electronically in a central venue (say one of the ecns), as this can then feed both sides of it to DTCC/Swapswire for confirmations, then on to live in a big warehouse for its subsequent servicing.
So it appears the only work to do over the next cpl of years in order to meet your prediction of credit derivates killing off (or toned down – marginalising) the institutional credit bond offerings is;
- product education to ensure the funds get their mandate
- ensuring the platforms deliver sufficient flexibility in the structures that can be ‘traded’ on the platform. Now that sounds easy, but hearing what the institutional clients say is lacking in terms of “product” available for electronic IRS offerings, means the closest comparison in terms of electronic market that we have does not set a great precedent. So do we need a “liquidity hub” collaberation in the credit space to steer this in?
November 29, 2006 at 9:24 am
Ah, my arch nemesis “Onboarding”. Whoever invented the saying “necessary evil” surely glanced into the future & saw “Onboarding”!
Very good points Holky, and I certainly see CDS as a very institutional product. Regarding madates on real money accounts, they are slowly but surely getting sign-off to use derivatives to some extent. Amazing how a few years of sub-5% returns will inspire Trustees to learn a bit about them.
November 30, 2006 at 2:59 pm
[...] It’s no surprise the article predicts that customers will utilise algorithms for government bonds before credit (my latest 2c on e- Credit in this waratah post), and that the fixed income algos move will only occur as a “next step” after the buyside conquer using their algos for foreign exchange. [...]
July 17, 2007 at 10:06 am
[...] ECNs , The Future , Credit In one of my first blogs last year, I mentioned that e-trading in institutional cash credit had failed, or was in the process of failing. Most comments seemed to agree, placing the blame on the market [...]