Liquidity conditions in the corporate bond market are expected to improve as electronic platforms gradually replace traditional over-the-phone trading, with new artificial intelligence tools helping to match dealers with buyers.
Liquidity conditions in the corporate bond market are expected to improve as electronic platforms gradually replace traditional over-the-phone trading, with new artificial intelligence tools helping to match dealers with buyers.
The fixed income market has historically relied on phone calls to arrange trades, but this is already being replaced by electronic trading at the more liquid end of the market, which includes government and sovereign bonds.
Meanwhile, the more illiquid corporate bond market is expanding rapidly as low interest rates across are adopted across many developed economies. However, some of these bonds can wind up “trapped” in portfolios due to the difficulty of finding buyers.
“The problem we’re trying to solve is…how do we make the outstanding supply of corporate bonds more tradable? How do we bring back some of these bonds that get trapped in a portfolio, and make it so that you can sell them?” says Bill Gartland, VP of fixed income data and analytics at Broadridge Financial Services.
“Particularly in credit, there’s still this perception that liquidity conditions are such that I can trade the newer bonds pretty actively but once they reach a certain age, after the issuer has put out other bonds in the market, the ones I have now are harder to trade,” says Gartland.
Broadridge is trying to improve liquidity in the market through the use of artificial intelligence. Its bond trading platform LTX uses AI to find and connect dealers with the right buyers.
The firm says it can suggest the right buyer for a bond “between three-quarters and 90 per cent of the time”, among a list of 25 names of clients to engage with.
Broadridge uses a neural network based on transaction histories of its dealer-side and buy-side clients going back between six and 24 months, to find the most likely buyers for a particular bond.
“What this often does is it surfaces the names that are less ‘knee-jerk’. When BlackRock is high on your list of clients to engage with, it doesn’t shock anybody, but when a Midwest insurance company is high on the list, it makes you think ‘Oh, yeah, maybe I should call them’,” says Gartland.
Insight into liquidity conditions is becoming more important as the corporate bond market continues to grow at breakneck pace. According to Gartland, the US market is already 15 per cent bigger than it was last year.
US companies went on a borrowing spree in 2020, with many firms issuing bonds to tide themselves over in the face of shrinking revenues due to Covid-19. Investment-grade companies issued a record USD1.7 trillion of bonds, a 60 per cent increase on the previous year’s total, according to ratings agency S&P.
Daily corporate bond trading volumes in the US are on the rise, having climbed 16.2 per cent year-on-year to USD41 billion in 2020, according to research from SIFMA. This shot up another 15 per cent in the first quarter of 2021 alone.
Nevertheless, the bonds that are being traded still represent a small fraction of the total size of the US corporate debt market, which is estimated to be worth almost USD10 trillion. Of the bonds that do trade, fewer than 25 per cent are traded electronically, with the majority still trading over the phone.
This figure is expected to grow. According to a recent survey by JPMorgan, asset managers predict that 40 per cent of all their corporate bond trading will be electronic by 2022. Around half of government bond trading is already electronic, and this is predicted to rise to two thirds by 2022.
A larger outstanding supply of bonds makes liquidity a critical issue for dealers and asset managers, who need to be able to buy and sell these assets quickly. In particular, buyers and sellers of bonds are often faced with issues when trying to trade older debt.
This is an issue for asset managers as they attempt to build, optimise and rebalance their portfolios.
Gartland explains: “Portfolio managers will often get the result of their portfolio optimisation tool saying, ‘Sell these, buy those’, and the first thing that the traders do is they say, ‘I can’t sell those, I’ll never get a good price for it, so I’ll sell something else’. Or, ‘I can’t buy those, because they’re never available, so I’ll buy these instead’.”
Gartland says that improving liquidity conditions will also make it easier for portfolio managers to match an index, as they can get better index tracking results if they have more choices of what they can buy.
Asset managers attempting to sell large blocks of bonds at once may also benefit from electronic trading. Broadridge has developed a separate protocol to allow dealers and buyers to aggregate liquidity across multiple buyers, called RFX.
AllianceBernstein recently became the first buy-side firm to receive aggregated liquidity from multiple buyers on the same block trade.
“A challenge facing many asset managers is how to trade blocks of bonds more efficiently,” said Tim Kurpis, head of investment grade trading at AllianceBernstein. “Most electronic solutions focus on smaller sizes and liquid bonds, but 70-75 per cent of the corporate bond market still trades over the phone.”
Over 10 dealers and 40 asset managers representing a significant liquidity pool have joined the LTX platform, with an additional 50 firms in the pipeline to join at midyear, according to Broadridge.
