(This article was originally published Thursday.)
--Regulatory uncertainty leads big banks to scale back
--Electronic trading lowers barriers to new or once-marginal
firms
--New dealers won 24% of trades in the first quarter, up from 2%
in 2008
--More competition seen narrowing trading costs
By Katy Burne
As bulge-bracket dealers scale back their roles as middlemen in
bond trading to conform to new regulations and corporate
strategies, a host of smaller broker-dealers have been scurrying to
fill the void.
So far, however, views are mixed about how helpful the new
entrants have been. Some investors have pointed to the large sales
teams of traditional broker-dealers, noting they are still a big
force in the market, despite their decision to pull back.
The beginning of any shift isn't only an opportunity for new or
formerly marginal firms such as Stifel, Nicolaus & Co. and
Susquehanna Financial Group LLLP to grow quickly. By encouraging
competition, it may help to offset some of the increased trading
costs that investors see as a consequence of tighter capital rules
on banks.
Some investors said the new firms are making a challenging
marketplace smoother, for example by helping them trade in and out
of older bonds, referred to as "off the run" because they aren't
the latest bonds to be sold by a borrower.
Bill Eastwood, head of trading at Newfleet Asset Management,
which has $8.6 billion in fixed-income assets under management,
said off-the-run bonds now trade almost "by appointment," and
buyers have to "make sure they are getting paid for the fact [that]
liquidity is going to be lower in that security."
Historically, broker-dealers have had the capital, and the
willingness, to buy less liquid bonds and hold onto them. Now,
bigger firms are less inclined to do so, hurting liquidity in older
bonds. In the case of bonds from steelmaker ArcelorMittal (MT), the
gap between risk premiums on old bonds versus newly issued bonds
reached 0.25 percentage point in June, up from 0.05 point in
February.
Established broker-dealers have increasingly taken on less risk
since 2008, serving as agents on trades rather than as principal
dealers taking bonds into their own inventories. Only 1.7% of
investment-grade bond trades were done on an agency basis in 2008,
compared with a recent peak of 3.8%, according to Benchmark
Solutions, which offers bond-pricing services.
As a result, some investors have had to split up their trades
into smaller chunks. About 11% of corporate-bond trades reported in
the first quarter were less than $1 million in size, versus just
more than 4% in the 2008 period, Benchmark said.
Meanwhile, the growth in electronic-trading venues has helped
trumpet the arrival of newer firms. MarketAxess Holdings Inc.
(MKTX), which runs an electronic-bond-trading platform, has added
38 dealers to its system since the crisis; its tally of dealers on
the platform now sits at 87, up from 49 four years ago. In addition
to Stifel and Susquehanna, the crop of new firms includes BNY
Mellon Capital Markets (BK), Cortview Capital Securities LLC,
KeyBanc Capital Markets (KEY) and U.S. Bancorp Investments
(USB).
Those new dealers added since 2008 won a 24% share of
investment-grade bond business by individual-trade tickets in the
first quarter on MarketAxess, according to the latest data
available, up from 23% in the year-earlier period and just 2% in
the third quarter of quarter of 2008.
John Johnson, head of credit trading at Aberdeen Asset
Management, which oversees $296 billion in fixed-income assets,
said it may take longer to do a trade these days, because the newer
broker-dealers aren't taking risk themselves, but the price is
better and "otherwise these trades might not be getting done."
Net primary-dealer positions in corporate bonds due in more than
one year are down 80% from their precrisis peak in 2007, according
to the Federal Reserve Bank of New York.
The emergence of lower-tier dealers comes as Wall Street faces
pending regulations, such as the Volcker rule that will limit banks
from taking risks with their own money. As banks prepare for these
rules, their customers have complained that they have found it
harder to trade in size, leading companies, including Goldman Sachs
Group Inc. (GS) and BlackRock Inc. (BLK), to prepare new venues to
boost volumes in the $8 trillion corporate-bond market.
"The fact that some dealers are less willing to provide
liquidity in the fixed-income markets creates a greater opportunity
for the second-tier firms to step up and move into the space they
have vacated," said Stephen Kardos, managing director in
fixed-income capital markets at Stifel, Nicolaus.
"Smaller dealers that are competent and who use capital
judiciously have become more relevant," said Bradford Bodine,
senior managing director at Cortview Capital, a broker-dealer
launched in 2010 with backing from private-equity firm Warburg
Pincus LLC.
MarketAxess sees about 12% of investment-grade bond trades that
are publicly reported because a large volume of trading occurs over
the phone. But it gets the lion's share of electronic trades among
institutional investors, particularly in highly rated corporate
debt.
Other venues have noticed the trend, too. BondDesk, which runs a
platform for individual or "retail" investors, said the number of
dealers offering live daily prices in corporate bonds had increased
to 119 this year from an average of 67 five years ago. Meanwhile,
the percentage of quotes offered by large dealers fell to 37% from
66% over the same period.
While some bond experts said they believe these new competitors
will help moderate trading costs as big banks back out, others said
the presence of lower-tier dealers can help only at the margin
because they aren't yet big enough.
"New dealers are an important piece of the puzzle, but there is
no evidence to show they are providing a whole new level of
liquidity," said Tim Grant, managing director of Benchmark
Solutions.
MarketAxess data and independent research show investors save
more money when sending trade enquiries to a broader number of
dealers. As of mid-June, the average price differential between
what it costs to buy and sell high-grade corporate bonds was 0.14
percentage point, down from almost 0.40 percentage point in late
2008, according to publicly reported data.
The crisis of 2008 was "the first crack that allowed other
dealers to get in," said Scott Colyer, chief executive of Advisors
Asset Management, which manages about $7 billion of client assets.
"Bond trading is very quickly going the way equity trading went and
the price of execution is coming down very quickly."
Write to Katy Burne at katy.burne@dowjones.com.
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