The fixed-income trading desks of larger money managers are setting prices of trades instead of discovering them while applying the electronic trading skills of their equity brethren to adapt to the changing nature of the secondary bond markets at a time of lower liquidity.
With federal regulations reducing the amount of inventory that investment banks are holding and putting overall liquidity at a premium, managers like BlackRock Inc., State Street Global Advisors and AllianceBernstein Institutional Investment Management are taking responsibility for price-making, particularly on credit markets. They're also using equity traders with experience in electronic trading to use bond automated-trading systems.
The changes, managers say, are intended to get better execution in the bond market and, ultimately, to help improve fixed-income returns.
“The market-making model is gone,” said James Switzer, global head of credit trading, AllianceBernstein, New York. “Now you're looking at an agency model. Now, the broker is basically acting as a bookie. ... The toughest thing in the market on the buy side is price discovery. Traditionally, the market has used the Street as a crutch to price credit. Now the responsibility falls on us to set the price, not wait for it to be set.”
Current changes in fixed-income trading have revolved around three points, said Christopher Rice, senior managing director, global head of trading, SSgA, Boston:
•changes in work flows;
•leveraging data to find best execution; and
•the “electronification” of the trading desk.
Those three “create more leverage on the trading desk, where they've moved from price-taker to price-maker and liquidity provider,” Mr. Rice said.
The implementation of regulations — like the Volcker rule banning banks' proprietary trading, as well as having to back fixed-income inventories with increased capital under the Dodd-Frank Wall Street Reform and Consumer Protection Act and Basel III — has made it tougher to trade bonds. And while many managers saw this coming when Dodd-Frank was passed in 2010, it's now — as the threat of rising interest rates hangs over the market — that the impact of the regulations is being felt.
“I think the writing is on the wall,” said Kevin McPartland, principal and head of market structure, Greenwich Associates, Stamford, Conn. “The Federal Reserve has given a lot of indication that rates will be rising, and when it does there won't be a sell-side buffer. It all comes back to that. Managers realize that and this is how they're taking action to deal with it.”
Richard Prager, managing director and head of BlackRock's trading and liquidity strategies group, New York, agreed. “There have been a lot of catalysts to accelerating the changes in trading. The big ones are the change in regulation and the amount of risk capital banks have on inventory. There's a need to change. Let's face it, the plumbing of the (over-the-counter) market is a bit creaky.”