Corporate Bond Market Slowly Embraces Electronic Trading

Getting Wall Street banks to hang up the phone and embrace electronic trading in corporate bonds has never been easy, but there's evidence the old guard is finally learning some new tricks.

Tradeweb Markets, a derivative- and bond-trading system owned in part by Goldman Sachs Group and JPMorgan Chase & Co., has secured a toehold in the $8.6 trillion U.S. corporate bond market. Three years after it first offered corporate bond trading, the firm now handles roughly 1% of volume electronically, according to Raymond James & Associates. In a market dominated by giant investment banks, where 80% of volume continues to be transacted over the phone or by chat message, that looks like a revolution.

Wall Street firms have maintained their grip on the market through their role as debt underwriters, giving them the power to allocate newly issued bonds to favored clients. Goldman Sachs, JPMorgan, Morgan Stanley and their peers also have the most comprehensive view of the market: they, not their asset manager customers, have the best access to price data, in part because only they can see trades done between banks. The phone has long been the preferred means of passing on that intelligence to customers.

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"The dealers are coming around," said Kevin McPartland, head of market structure research at Greenwich Associates, a financial services consulting firm based in Stamford, Connecticut. "There is still a strong place for them in the market even if the execution becomes more electronic."

While Tradeweb's 1% market share is tiny, it shows the firm is gaining traction, a rare accomplishment for startups trying to upend the status quo. Several firms have tried to popularize bond trading over computers, including Goldman Sachs, BlackRock, MarketAxess Holdings and a slew of bank-led consortiums with code names like Oasis and Neptune. Many of those efforts flopped, partly because dealers were worried they'd weaken a lucrative segment of their business if trading changed too much.

Fixed-income profit is one of the last vestiges of Wall Street dominance, which banks guard fiercely. Though revenue from fixed-income sales and trading is down 42% since 2009, that business brought in $68 billion for the world's nine largest investment banks last year, according to data compiled by Bloomberg Intelligence. That's more than any other broad business segment, topping equity trading, investment banking, underwriting and advisory services. Still, computer-based trading is creeping in because broker-dealers can only put off the inevitable for so long.

"The market continues to evolve, and we have to adjust to be responsive to that," Lee Olesky, chief executive officer of Tradeweb, said in an interview. "The banks are a critical component of our market. What's changing is everyone is connected up now."

Tradeweb is majority-owned by Thomson Reuters, with the rest held by Bank of America, Barclays, Morgan Stanley, Citigroup and other banks. Bloomberg, the parent company of Bloomberg News, competes with Tradeweb, MarketAxess and others in offering bond-trading services to its subscribers.

Still Early

The 1% market share figure at Tradeweb refers to the dollar amount of bonds traded there. By that metric, volume done electronically jumped 65% between November and June, the company says. Another measure shows Tradeweb handled 17.6% of industry trades placed last month, up from 12% seven months earlier, according to data compiled by the Trace trade-reporting service.

"While electronic trading is showing signs of traction, Tradeweb is still in the early days in terms of electronic execution for institutional clients," Raymond James analyst Patrick O'Shaughnessy wrote in a July 17 report.

About 80% of U.S. bond deals are still done over the phone or chat service, McPartland said. Unlike stocks or futures, corporate bonds aren't well-suited for computerized trading because the relative lack of supply in the U.S. corporate bond market makes the securities very sensitive to price information. Investors don't want to tip off the rest of the market to what they want to buy or sell, as that information can move prices and kill any chance at a profitable trade.

The part of the market that has gone electronic tends to be in smaller size trades where less profit or loss is at stake. In this arena, Tradeweb's largest competitor MarketAxess dominates the 20% that's electronic. In the first half of 2017, MarketAxess had electronic volume of $756 billion, a 17% increase from a year earlier, CEO Rick McVey said.

McVey said that one of the larger breakthroughs in recent years in the bond market is the ability for investors to trade with each other without a bank being involved in the transaction. It's called all-to-all trading, which on MarketAxess accounts for 16% of volume, McVey said.

Getting Comfortable

"There is no question in my mind that what we're observing is the large banks getting more comfortable in electronic trading of credit," he said. Dealers have embraced all-to-all trading to such a degree that 25% of all of these types of trades are initiated by a bank, he said. A few years ago that would have been unthinkable on Wall Street as bankers worried they'd get cut out of a lucrative market.

Tradeweb has shifted its strategy to combine previously distinct groups of traders into one big pool, Olesky said. Their 50 largest institutional customers are now combined with about 130 smaller or regional dealers, he said.

Tradeweb is also seeing investors increasingly willing to create prices for bond deals, traditionally the role of sell side banks. "That is going to continue to evolve, you will see more price providers come into the market, and it's not just all from the buyside," Olesky said. "As we've moved into the world of all-to-all, it's a wider universe of liquidity." Succeeding here is a question of, "How big is your network?" he said. "That's where we think we have an advantage."