Which corporate bond trading platforms are lost causes?

LONDON, Feb 13 (IFR) - Around 30 e-trading platforms are currently competing to address the liquidity crisis in corporate bond trading, but market players say most will fall by the wayside in the months ahead.

"There are 30-odd platforms currently looking for a share of activity," Mark Benstead, senior portfolio manager for UK credit at L&G, said at a recent credit conference.

"But there certainly won't be 30 in a year's time."

The surge of platforms comes as fixed income finds itself grappling with a new and confusing paradox: while the ability to conduct large trades has withered, there are more bonds than ever before.

As a result of stricter regulations and higher capital costs, dealers have shrunk their bond inventories dramatically.

According to the Federal Reserve Bank of New York, corporate bond inventories have decreased more than 75% since before the financial crisis, from around US$250bn then to US$57bn today.

But the net total of corporate bonds outstanding has skyrocketed from US$5.2trn in 2007, according to trade industry group Sifma, to some US$7.7trn now.

New platforms, some still just little more than an idea, are stepping into the breach to try to resolve this. [For list of platforms see FACTBOX: ID:L6N0VE553]

DIFFERENT PROTOCOLS

Some of the platforms are promoted by dealers, such as HSBC's Credit Place and PIN from UBS, while there are a raft of independent players, including Bondcube and Electronifie.

"When designing a platform, you are faced with an impossible trinity," says Frederick Ponzo, managing partner at GreySpark Partners, a consulting firm.

"You must pick a trade-off between transparency of price discovery, managing the time mismatch and protecting against adverse leakage of information," he told IFR.

"A corporate bond execution facility cannot achieve all three. In pursuing two, the platform operator must forgo the third."

The long-standing method of liquidity provision, dealer-to-client, where corporate bond investors ask multiple banks for prices on the dominant venues - Bloomberg, Tradeweb, MarketAxess and Bondvision - has hit a hitch.

This request-for-quote (RFQ) model has thrived for smaller transactions since the financial crisis but not larger, which require accurate pre-trade prices from dealers who also need to deploy capital to warehouse risk.

Securities analysis firm TABB Group's Anthony Perrotta estimates that from a low of 7% in 2008, 15%-16% of the notional volume for dealer-to-client trading is executed via an electronic medium.

But the various new platforms spy an opportunity to facilitate larger transactions. They believe investors want to be able to trade which each other but on platforms with neutral ownership structures and where access to the data is restricted.

It is probably for these reasons that early movers from 2012, such as Goldman Sachs's G-Sessions and BlackRock's Aladdin, failed to gain traction.

As it happens, BlackRock has since teamed up with MarketAxess with an offering called Open Trading, which allows investors to trade with other investors, and recently announced an expansion into Europe.

Last summer, Tradeweb launched a US platform on which it promised pre-trade transparency, with live prices and 95% certainty of execution on certain securities - which would be an impressive undertaking by dealers. (Tradeweb is 51% owned by Thomson Reuters, and IFR is a Thomson Reuters publication.)

New approaches

None of these developments has halted the march of new platforms, many of which are replicating exchange trading models, where users can trade with anyone - all-to-all. Only this week, SIX Swiss bourse launched a trade-matching venue, and Bondcube - backed by Deutsche Boerse - went live in December.

Other venues still in conception include Oasis, another all-to-all model created by Deutsche Bank, and Project Neptune, an attempt to link all trading venues, backed by a dozen banks, including Goldman Sachs, HSBC, Societe Generale, BNP Paribas and Credit Suisse.

However, there is a risk that Neptune, which will take at least a year to complete and needs substantial funding, will not be operational in time to act as a conduit for the new platforms. One of the major problems facing new venues is how to build sufficient momentum.

"If we trust the platform enough we would go up in big size in expectation that we'll get matched. But if you're not getting matched then you just give up and go elsewhere," says L&G's Benstead.

One platform that appears to have gained some traction is Credit Place, where investors can deal directly, but anonymously, with each other. This is facilitated by HSBC, which also services these clients with quotes and liquidity. Credit Place's average ticket size is around US$5.4m, versus an average corporate bond trade size of US$200k-$300k, according to HSBC.

Last year, US$23bn of orders were placed, triggering US$6.5bn worth of trades; the venue currently has 74 clients globally and HSBC estimates that will grow to over 100 by year-end.

"There's a lot of talk about matching platforms, but in credit and illiquid markets generally it is rare to achieve the perfect match," says Niall Cameron, head of markets, EMEA, at HSBC.

Finding the sweet spot

It is hard to shift from the idea that dealer-to-dealer activity is key to bridging the gap to the buy-side, which holds around 91% of corporate bond assets.

"We need to help dealers and not alienate them. The interdealer brokers should have been the winners in this situation and instead they are coming out the losers. So far, we haven't seen an interdealer exchange and this could ease the pain," says Ponzo.

There are several initiatives with dealer-to-dealer functions in the pipeline, including Swiss Exchange, Singapore Exchange and Neptune.

The idea that the existing market structure requires only a re-touch, not a complete overhaul, is behind Algomi's Honeycomb product, which has secured a strong following since it started in late 2014.

According to Stu Taylor, Algomi's chief executive, nine banks are live with the product or soon will be, including Credit Suisse, Deutsche Bank, HSBC and Nomura. The Swiss bourse also installing the system.

"Salespeople need to drag clients/holders into the arena to convince them to sell, and that isn't a 20/30-second protocol," Taylor says, adding that 30 major buy-side firms have already signed up and another 40 are currently in talks.

Despite the millions of dollars ploughed into e-trading, many doubt whether we can ever re-live pre-crisis highs of the financial bubble. It seems unlikely that an inherently illiquid asset can become liquid due to technological advances alone. (Reporting by Laura Benitez, Alex Chambers; editing by Julian Baker and Marc Carnegie)