More Corporate Bond Trading Goes Electronic

Investment-grade volume on the MarketAxess platform hit $44 billion in September.

A record share of U.S. corporate-bond trading has moved to computers as buyers who traditionally transacted over the phone seek faster ways to buy and sell in a market where Wall Street’s human traders are retreating.

Investment-grade volumes on MarketAxess Holdings Inc.’s electronic system are on pace to exceed $400 billion in 2013 after surging 45 percent to $44 billion in September from a year earlier, according to data from the company, which estimates it captures about 90 percent of electronic trades among the dollar- denominated notes. That’s equal to 14.3 percent of all market activity, including business done over the phone, up from 12.2 percent a year earlier.

Investors are seeking alternatives to establishing bond prices by calling multiple Wall Street firms, which experienced an estimated 20 percent decline in debt-trading revenue in the third quarter as they curb holdings used to facilitate trades. U.S. corporate-bond buyers expect to conduct 30 percent of their volume electronically by 2015, according to McKinsey & Co. and Greenwich Associates.

“The industry is very open to alternative solutions because of the inventory challenge with the dealers,” said Niamh Alexander, an analyst at Keefe, Bruyette & Woods who expects MarketAxess to capture 20 percent of investment-grade bond trading in the U.S. by the end of 2015. Investors are “open to it and the dealers are open to it as well.”

The shift has prompted firms from BlackRock Inc. to Goldman Sachs Group Inc. to explore creating their own platforms. BlackRock, which managed $3.86 trillion in assets as of June 30, considered helping to create its own network before saying in April it would instead route trades through MarketAxess. Goldman Sachs added trading sessions this year and increased the amount of money it makes available to buy securities on an electronic system it started in 2012, known as GSessions.

Deutsche Bank AG, the biggest bank in continental Europe, combined its investment-grade credit and interest-rates units in North America last year as it emphasizes its electronic debt-trading platform.


Cutting Costs

Moving to electronic bond-trading systems may reduce transaction costs by as much as five times because it forces dealers to compete more openly through automated auctions, according to a study last year by Terrence Hendershott, an associate professor at the Haas School of Business at the University of California at Berkeley, and Ananth Madhavan, global head of trading research at New York-based BlackRock.

“You want to induce more competition amongst the dealers,” Hendershott said in a telephone interview last week.

The 21 primary dealers that do business with the Federal Reserve have reduced net investment-grade bond holdings to $10 billion, an 11 percent decline since April 3, when the Fed started reporting the data, after cutting a broader measure of corporate debt by 76 percent since the October 2007 peak.

Investment-grade trading volumes on MarketAxess’s system expanded 21 percent in the first nine months of the year to $333.6 billion, from $275 billion in the corresponding period of 2012 and $248.1 billion in the first three quarters of 2011, according to data from the New York-based company.

The growth is three times the 7 percent increase during the same period in average daily transactions tracked by the Financial Industry Regulatory Authority. Average volumes on a given day increased to $12.7 billion from $11.9 billion, bringing total trades for the first nine months of the year to $2.4 trillion.

MarketAxess’s share of all investment-grade bond transactions in the U.S. swelled to as high as 16.6 percent in June as trading volumes fell to about the lowest ever as a proportion of the market.

“It’s harder and harder to call any one dealer and get liquidity,” said Peter Tchir, founder of New York-based hedge- fund adviser TF Market Advisors. “Longer term, I expect more bond and derivative trading to occur on electronic platforms.”

Investors use systems such as MarketAxess to request price quotes on bonds from multiple dealers at the same time, with the idea of accepting the best offer within a set period of time.

Traditionally, those prices have been negotiated directly between investors and brokers over the phone. Dealers buy a bond from a client at one price and sell the same security to another for a higher amount, profiting from the gap.


Transactions Shrink

While the dollar-denominated investment-grade bond market has increased 71 percent since 2008 to about $4.3 trillion, the size of each transaction declined to about $565,000 in the three months ended June 30, compared with about $970,000 in the first three months of 2007, according to Trace, Finra’s bond-price reporting system, which tracks both electronic transactions and those negotiated over the phone. The average investment-grade trade on MarketAxess’ system was $600,000, according to Rick McVey, the company’s chief executive officer.

“Dealers do not have the balance-sheet capacity to warehouse large block trades from investors the way they used to, so investors are breaking trades down into smaller sizes,” he said in a telephone interview.

Bloomberg LP, the parent of Bloomberg News, also offers electronic bond trading through its fixed-income trading platform and doesn’t disclose volumes.

Citigroup Inc., the third-biggest U.S. bank, reported a 26 percent slump in fixed-income trading revenue in the three months ended Sept. 30 from a year earlier, contributing to a $3.23 billion profit for the period that missed analyst estimates, according to a statement today from the New York- based lender.

Fixed-income trading revenue excluding an accounting adjustment dropped to $2.78 billion, compared with an estimate of $3.04 billion from Credit Suisse Group AG analyst Moshe Orenbuch.

The biggest U.S. banks’ fixed-income trading revenue probably fell 20 percent in the third quarter from a year earlier on lower volumes, Richard Staite, an analyst at Atlantic Equities LLP, said in a Sept. 23 report.

“It’s a reasonable-size business in terms of revenues for them, but they don’t have the balance sheet capacity to be the backstop for the market,” said Roger Rudisuli, a partner in McKinsey’s corporate and investment banking practice, speaking about dealers generally. “They cannot play this role anymore.”


Credit Benchmarks

Elsewhere in credit markets, a measure of corporate credit risk in the U.S. fell to an almost five-month low as Senate leaders were poised to reach an agreement as early as today to bring a halt to a fiscal standoff that has threatened to tip the nation into default. Creditors of Energy Future Holdings Corp., taken private in the biggest leveraged buyout on record, will keep negotiating for a restructuring plan after one group quit confidential talks.

The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, fell 0.7 basis point to 76.2 basis points as of 10:01 a.m. in New York, according to prices compiled by Bloomberg. The measure is trading at about the lowest level since May 22 in data that adjusts for the effects of the market’s shift to a new version of the index last month. Bond markets were closed yesterday in the U.S. for the Columbus Day holiday.

The emerging Senate deal would stave off a potential default by extending the nation’s borrowing capacity, end the 15-day-old government shutdown and change the immediate deadlines in favor of three new ones over the next four months.

In London, the Markit iTraxx Europe Index, tied to 125 companies with investment-grade ratings, fell 2.4 basis points to 89.3 basis points.

The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million.

In the Energy Future talks, outlines of three unadopted proposals submitted by different groups were included in a filing today with the U.S. Securities and Exchange Commission. Each would have restructured more than $40 billion of debt via pre-negotiated bankruptcy filings by the company and most of its units, excluding regulated power-line group Oncor Electric Delivery. All of the plans contemplated keeping the company and its units together post-Chapter 11.


Lenders Divided

Creditors are seeking to reach terms on a pre-arranged bankruptcy filing by Nov. 1, the filing shows. Lenders are divided over how much of Energy Future’s $43.6 billion in debt will be extinguished, and how lenders will carve up ownership of the Texas power company. Energy Future is due to make about $270 million in interest payments Nov. 1 -- cash more senior creditors want the company to retain by filing for bankruptcy.

Texas’s largest electricity provider has struggled to reduce debt since it was taken over in a $48 billion deal in 2007 led by KKR & Co., TPG Capital and Goldman Sachs Capital Partners. The leveraged buyout left Energy Future with more than $40 billion in debt in an unsuccessful bet natural gas prices would rise.


Bloomberg News


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