John Brazier: The Buy Side Has Never Had It So Good

After spending the first two months of the year examining the corporate bond market, it became apparent to me that while there are undoubtedly ongoing issues that need to be resolved on both sides of the street, electronification is making slow but steady headway in addressing the fixed-income market’s well-documented liquidity problems.

Take, for example, the recent announcement from MarketAxess that confirmed the vendor’s plan to expand into the $3.6 trillion municipal bond market by April. Electronification has yet to have any serious impact on this segment of the bond trading market, but for a firm with the clout of MarketAxess to make a serious go of it displays clear optimism regarding the buy side’s buy-in. 

Meanwhile, Liquidnet’s dedicated fixed-income dark pool for US and European corporate bonds (high-yield and investment-grade), emerging market corporate bonds, and European convertible bonds exceeded the $1 billion mark in trading volumes just five months after its launch late last year. So for all the talk of liquidity mirages or crises regarding the ongoing issues surrounding access to pre-trade information and inventories, there are clearly a lot of positives out there for fixed-income buy-side players to draw on. 

Constraints 

Since the arrival of increased capital constraints post-2008, the balance of power when it comes to bond trading has shifted from the sell side to the buy side. One source on the buy side recently told me that he believes that those larger sell-side institutions that escaped the credit crisis relatively unscathed would soon find themselves in a bond-related mess as the industry contracts. 

The balance of power when it comes to bond trading has shifted from the sell side to the buy side.

The issue for the buy side is how to take advantage of what is now a more favorable marketplace, and many such players have adopted technology as the primary tool in order to do so. There is certainly no lack of electronic trading facilities in the market right now, with current estimates totaling around 100 different trading platforms and utility models, either operating or nearing launch. That in itself can be problematic though: Mid-sized asset managers simply don’t have the resources to connect to all the various utility programs going on and must therefore pick carefully which projects to get involved in. However, there are no guarantees of ever seeing tangible returns, although utilities also need support from the sell side to flourish, so it’s something of a gamble. 

Then again, you’d be right to point out that almost all activity that takes place within the capital markets is a gamble in some form or other, regardless of the degree of calculation, but when the costs involved are excessive and unnecessary, and the possible jackpot meager, I imagine many players would opt to stick with what they have rather than twist and join too many ambitious new projects.

Almost all of the market participants I have spoken to in the bond trading market agree that consolidation is only a matter of time for many of the existing platforms, and that the likely outcome is the emergence of a handful of large, specialized trading facilities for Europe, the US and Asia. It’s an issue for the buy side of backing the right horse.

As I wrote in my February feature, “Fixed-Income Liquidity: An Alternative FIX,” the liquidity challenge in the bond trading market is not one of no liquidity—evidenced by the strong numbers being touted by various trading platforms at present—but one of transparency and access to liquidity and the provision of pre-trade information. It’s an area that several projects and utilities are looking at with varying degrees of success, but it is the recognition that execution is not the only factor at play in the bond trading space that the buy side can benefit from the most, as the ease with which pre-trade indications can be sent to market increases. 

Joni Mitchell once sang “you don’t know what you’ve got until it’s gone” in Big Yellow Taxi, a sentiment the buy side would do well to contemplate, given that they have never been in a better position to capitalize on the range and variety of trading technologies currently on offer. Perhaps they should also heed another 1970s music legend, Jimi Hendrix, and “let the good times roll.”