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US Corporate Bond Market Seeks New Trading Solution as QE Tapering Looms, Says TABB Group Research

Danger signs in the US corporate bond market are flashing like a lighthouse’s beacon and according to new TABB Group research, the market is searching for new alternatives to trade credit as low interest rates have driven credit issuance to all-time highs.

The challenge, according to Larry Tabb, CEO, and director of fixed income research Will Rhode, co-authors of a new research study, “US Corporate Bond Trading 2013: In Search of a New Market Structure,” is that the current OTC market structure revolves around dealer balance sheets and leverage, which today are under siege by regulators and are being scaled back by bank management. “This is pushing the traditional dealer-based, capital-intensive and voice-based market toward electronic channels. While the existing electronic players are active, well used and supported, many of the current structures revolve around existing capital-intensive business models. That leaves the credit market with unmet needs and significant challenges,” says Tabb.

After speaking in September with heads of trading of the largest buy-side fixed-income managers and global heads of credit, or heads of credit e-commerce, of the largest bond dealers, TABB Group learned there is uniformly strong demand for a new corporate bond market structure allowing diverse sources of liquidity to find one another as the end of Quantitative Easing (QE) nears. However, warns Rhode, “solving these issues will take investment, guts and breaking (or at least bending) established business models. Improving liquidity in 70,000 corporate bond issues (CUSIPs) is a Herculean task.”

Key findings from the study:

  • 85% of buy-side and 83% of sell-side firms are interested in seeing an independent platform emerge to facilitate liquidity challenges, but there is no clear consensus on a business model and rules of play.
  • The buy side would like to see a Central Limit Order Book (CLOB); dealers lean toward a Session-Based market.
  • Dealers are worried about their ability to provide capital amidst new regulations such as Basel III, leverage ratios, stress testing and increased scrutiny of dealer funding through repo.
  • Fixed-income mutual funds have absorbed an additional $1.35 trillion of fixed-income assets, In June 2013, when hints of a reversal of the US Federal Reserve’s backed up interest rates, mutual investors dumped $200 billion in bond funds in only a few weeks.
  • Although a majority of buy-side firms are reluctant to take an ownership stake in a new bond platform, most (buy and sell side) agree that dealers must own a stake in a new platform for it to succeed.
  • More than three-quarters of the buy-side said now is the time for an Alternative Trading System (ATS) to emerge to take market share away from the traditional OTC market dealers and existing electronic platform providers.

While the challenges are sufficient enough to foment change, the catalyst for action is not yet in sight. “Nonetheless,” says Tabb, “the time may be ripe for a new corporate bond trading platform (or trade protocol) to emerge to challenge the status quo.”

The 32-page study with 46 exhibits can be downloaded by TABB Group Research Alliance Fixed Income clients and pre-qualified media at http://www.tabbgroup.com/Login.aspx. For a copy of the Executive Summary or more information, visit www.tabbgroup.com. To purchase the report, write to [email protected].

About TABB Group

Based in New York and London, TABB is the only research and consulting firm focused exclusively on capital markets, based on the interview-based, “first-person knowledge” research methodology developed by Larry Tabb. For more information, visit www.tabbgroup.com. In 2010, TABB launched TabbFORUM, the online capital markets community for peer-to-peer opinion and analysis covering current industry issues, tracked daily by 18,000-plus professionals; in October, 2013, QuantFORUM, a new online channel for the quantitative investing community went live.

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