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Wall Street banks have seen electronic trading chip away at their control of the corporate bond market. Now they're fighting back.

bond trader computer screens desk
Traders on the trading floor of the Spanish bank Bankinter during a Spanish bond auction in Madrid in 2012. REUTERS/Susana Vera

  • Some of the biggest banks that serve as corporate bond dealers, including Bank of America, Citigroup, Goldman Sachs, JPMorgan, and Morgan Stanley, are actively working with their clients to help facilitate direct electronic trading.
  • This would mean bypassing electronic marketplaces such as MarketAxess, Tradeweb, and Bloomberg, which risk losing out on these trading volumes.
  • Some say direct trading isn't an immediate threat to the electronic venues and instead represents a natural progression of the electronification of the fixed-income markets.
  • Visit Business Insider's homepage for more stories.
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Investment banks that help big money managers trade corporate bonds are looking to lead the next great change in the rapidly evolving fixed-income markets.

The US corporate bond market, which stood at $9.2 trillion in 2018 according to data from the Securities Industry and Financial Markets Association, has traditionally traded over the phone because of its size and complexity.

In recent years, however, an increasing amount of volume has begun to trade electronically thanks to the rise of electronic trading marketplaces like MarketAxess and Tradeweb. These types of venues handle roughly 26% of all US corporate bond trading, the vast majority of which involves smaller bonds that are easier to transact on and therefore considered more liquid.

Now, numerous leading investment banks are looking to trade corporate bonds electronically with their clients directly, potentially cutting out these electronic trading marketplaces.

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Bank of America, Citigroup, Goldman Sachs, JPMorgan, and Morgan Stanley are among the large US dealers actively working with hedge funds and asset managers to allow them to electronically trade on prices sent directly to them from the banks, according to multiple sources familiar with the matter.

Banks have already begun streaming prices electronically to their clients and either are trading direct with a select group of clients or will have the ability to do so "imminently," sources involved with the efforts said.

Jim Switzer, the global head of fixed-income trading at the $555 billion asset manager AllianceBernstein, said his firm was already connected directly with a few dealers and had done trades as a proof of concept. He described the effort as a top priority for the firm.

"For us, the whole direct connectivity is just all about efficiency," Switzer told Business Insider. "Electronically we ask, 'Where would you offer us $10 million?' They give us a price. We say done. And everything just auto-books. Messages. Confirms. We don't touch anything. That is the goal."

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Bond trading has been a fast-evolving space in recent years

MarketAxess is the largest electronic venue for US corporate bonds, handling roughly 85% of all electronic volume, according to research from Greenwich Associates. Tradeweb, which went public in April, handles about 9%, with the rest split among Bloomberg (3%), Trumid (2%), and Liquidnet (0.5%).

Read more: JPMorgan and Citigroup just closed bond desks for smaller trades in favor of algorithms. It's another sign that robots are taking over.

The shift to direct electronic trading, according to some, could represent a serious threat to the dealers that have helped US corporate bond trading evolve thus far. By connecting directly with their clients, dealers could avoid the trading platforms altogether, saving on fees and ensuring their pricing information remains private to just their clients.

"Sophisticated clients and dealers are realizing that the overhead for electronic trading is getting out of control," Chris White, the CEO of the pricing-data startup BondCliq, told Business Insider, referring to the fees charged by bond-trading platforms.

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Representatives for the banks, MarketAxess, Tradeweb, and Bloomberg all declined to comment. Trumid could not be reached for comment, despite multiple attempts.

Others don't view the trend as an immediate threat to the electronic marketplaces. Instead, they see it as a natural progression for a space that has seen rapid changes over the years thanks to continued technological development.

"It certainly makes sense to be able to have a market structure that creates many and different opportunities for trading. Some will include platforms, some will not," Constantinos Antoniades, the global head of fixed income at Liquidnet, told Business Insider. "There is no reason why direct client-to-dealer electronic trading should not be part of the tool kit of investment managers."

Banks are trying to keep up with the latest innovations

The push by banks to connect directly with their clients could also be viewed as an attempt to grasp on to a business that in many ways has begun to slip away from them thanks to recent innovations in the space.

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In April, Bloomberg reported on how the rise of all-to-all trading, in which investors can trade anonymously with one another, was cutting banks out of bond trading. The Wall Street Journal reported later that month that the high-frequency-trading firm Jane Street had recruited roughly 60 clients for its US corporate bond trading business.

Meanwhile, banks have seen credit-trading revenue drop sharply. In 2018, revenue in the fixed income, currencies and commodities businesses at the 12 largest global banks dropped 5% from the previous year to $64.2 billion, according to data from the research firm Coalition. Credit was a particular drag, decreasing by 21% from 2017's revenue.

And some banks are unhappy with the fees charged by electronic platforms

In addition, several e-trading executives said they were unhappy with the transaction fees charged by some of the trading venues, which they feel are increasingly cutting into their profits. One executive said the cost to trade on some marketplaces was closer to that of a broker fee than to fees typical for a venue. Despite attempts to negotiate lower fees, electronic trading venues have not been receptive, another executive added.

And while banks have seen their profits from bond trading dwindle, the operators of electronic platforms have enjoyed considerable financial success. MarketAxess reported record revenue ($124.5 million) in the first quarter of 2019. Tradeweb got a 27% bump in its stock price when the company listed in April, opening at $34.26 a share. On Tuesday, the stock closed at $39.25.

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Protecting pre-trade pricing data is another concern for banks, according to sources. As more volumes trade electronically, the operators of the venues could collect and sell the market data back to participants at a premium. Just as stock exchanges have greatly profited from selling data collected on their venues, so too could those operating markets in the corporate bond space.

But even worse than having to pay for the data, according to some, would be the actual distribution of it. Doing so could negatively affect banks' ability to trade. In an opaque market, greater exposure of how dealers are pricing their inventory of bonds could make it harder for them to move them at favorable prices.

By going direct to clients electronically, banks can be more selective in the sharing of their information, as opposed to widely distributing it on an electronic platform.

"With regards to data, the concerns from banks and clients make a lot of sense," Antoniades said. "Banks have invested heavily in price generation and clients don't want their data to be used without any benefit to them."

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Read more: MarketAxess just released a key tool for improving how fixed-income ETFs are built, and it could lead to further automation in the market

Other banks, however, believe the trend just represents the next step in the progression of the market, according to sources. Direct trading will merely be another option investors have when considering how they'd like to trade corporate bonds.

Instead of cannibalizing electronic platforms' market share, direct trading is more about digitizing larger deals that have yet to begun trading electronically, some bank executives said. Small corporate-bond transactions, known as odd lots, are likely to remain mostly done on the electronic trading venues. Larger deals that still take place over the phone could start to be handled electronically via direct trading.

No matter the motivation behind the move, it's not likely to happen overnight. A level of technological sophistication is required to trade directly that some investors simply don't have, sources said. The various "pipes" — as they are referred to by those in the industry — by which a hedge fund or asset manager could receive prices from a bank and trade on continue to develop.

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One route is banks connecting direct to an asset manager's custom-built order and execution management system. Another is commercial OMS/EMS providers, of which there are a handful in fixed income, working with dealers to offer prices directly from them.

A third option is for both banks and investors to connect to a utility that would manage the connections at a low cost to the industry. Neptune, which launched in July 2016, fits that bill. It offers pre-trade bond data between banks, of which over 25 are on board, and investors. It does not, however, support trading.

And while banks have been proactive working with their clients to help them with the process, there will be those that aren't interested in investing additional resources to set up direct-trading capabilities.

Still, in a market as top-heavy as US corporate bonds, where more than half the notional volume is handled by the top five dealers, an initiative led by just a few firms can have a significant impact.

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For Switzer of AllianceBernstein, it's illustrative of a larger shift in the industry. Long gone are the days when knowing the availability of bonds was something that could wait until the last minute.

"Liquidity needs to go to the front of the investment process," Switzer said. "At any given time we have to know what is the investable universe, and we need to optimize our portfolios off of that. Because you can't just go out there and buy and sell whatever you want anymore."

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