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Curatia Analysis for Tue, May 14

Convertible Bond: The Brewing Rivalry Between Banks and Electronic Bond Trading Platforms

Financial media has cast a spotlight on electronic bond trading of late as bond market electronification continues to gather pace. That heightened attention has highlighted an unfolding contest between banks and electronic trading platforms — once playing complementary roles — for trading volume.

The new dynamic has increasingly heaped pressure on incumbent Wall Street banks to present a credible alternative to narratives of inevitability and technological progress in electronification as they rally to defend market share.

Into the Spotlight

Recent weeks have seen robust coverage of bond market electronification. The IPO of bond trading platform Tradeweb, whose shares soared more than 50% in the weeks after its April debut, has stood out as a success even as other high-profile offerings like Lyft and Uber have foundered.

Competing platform MarketAxess, which handles 85% of US corporate bond trading, has meanwhile grabbed headlines with ambitious maneuvers to maximize the value of electronic platforms to traders.

In April, it announced a partnership with HFT power Virtu to embed Virtu’s “RFQ-hub” ETF trading platform into its own bond trading platform.

MarketAxess also unveiled five new indexes to help ETF sponsors identify actively traded bonds for inclusion in ETFs. And last week it detailed plans for a live order book to give market participants “a view of two-way, actionable prices” in actively traded bonds on its platform.

Progress, Inevitability

Those high-profile moves have helped reinforce narratives of inevitable improvement around bond market electronification, which financial media have often described as “progress” or “evolution” despite some participants’ stated preference for conducting trades via voice.

Frequent mentions of “catching up” to equity markets, where 80% of trading is conducted electronically, also fuel those narratives.

“The movement is towards automation and that’s not stoppable in the long term,” George Bollenbacher, head of fixed income research at Tabb Group, said.

Threat To Incumbents

Those narratives pose a distinct threat to the Wall Street banks that have long dominated the bond trading ecosystem in the US — as do recent market trends. 26% of US corporate bond trading now occurs electronically.

Post-crisis regulation has encouraged banks to focus on the largest, most profitable bond trades while ceding smaller trades to electronic trading platforms — a market symbiosis of sorts.

Recently, though, banks and bond trading platforms have begun vying for the same turf. In 2018, the 12 largest global banks saw credit-trading revenue drop 21% YoY.

Response

To meet that challenge, banks have shifted tactics, bypassing electronic trading venues in the sprawling landscape of corporate bonds to conduct electronic trades directly with their clients. BAML, Citi, Goldman, JPMorgan, and Morgan Stanley are all working with hedge funds and asset managers to allow direct electronic trading.

Banks are also establishing a narrative around direct electronic trading: efficiency. By cutting out electronic trading platforms, banks argue they can reduce fees and keep pricing data private to their clients — a pitch that appeals to buy-side traders in a hypercompetitive environment.

Banks are also looking to electronify new corporate bond issues to fend off fintech challengers. In an initiative dubbed “Project Mars,” a group of banks led by BAML, Citi, and JPMorgan has set up a company, appointed a CEO, and invited money managers including AllianceBernstein, BlackRock, and Invesco to test its platform for “modernizing” new issues.

Munis

Banks’ market-share tug-of-war with corporate bond trading platforms could be a harbinger of things to come in sleepy munis markets, which have seen a recent explosion in electronic trading.

From December 2017 to January 2019, the share of municipal bonds traded on ATSs nearly doubled from 4.7% to 9.1%. In all, 12-15% of trading in munis is electronic — a trend that, according to Greenwich, “is only just getting started.”

The three biggest securities dealers meanwhile handled fewer than 20% of trades executed in state and local munis in 2018 – down nearly a third from the 29% they handled in 2011.

Snowballing Trend?

More broadly, the share of trading in bond markets conducted electronically could snowball if electronic trading platforms garner enough volume to draw interest from algorithmic traders.

In addition, a stint of sustained volatility — which heightened trade tensions seem to be invoking — could juice bond market electronification as investors seek oases of liquidity into which to dump riskier high-yield bonds or from which to embrace the safety of US Treasuries.

Against that backdrop, banks seeking to defend bond trading market share may find solace in an old adage: If you can’t beat ‘em, join ‘em.