Will Rhode, Tabb’s director of fixed income research

Corporate bond market undergoing radical transformation, says Tabb

The corporate bond market is changing and in far more wholesale a fashion than a mere e-trading trend, says Tabb Group.

In new research, “Corporate Bond Market Transformation: Dealers, Platforms, Investors”, Tabb says that at the very core banks are re-evaluating their role in a market they have dominated, dictated and designed for over 50 years. But today, returns are lower, costs and risks are higher. They are looking at how to realise efficiencies, adopt new business models or exit the industry entirely.
 
According to Will Rhode (pictured), Tabb’s director of fixed income research and the study’s author, banks have reported fixed income losses of USD8bn on an aggregate basis since early 2008.

“Capital charges under Basel III are forcing several to leave the business. In the US, quantitative easing (QE) has created doubt over the logic of the traditional over-the-counter (OTC) business, leading banks to question why they should continue to house inventory if interest rates remain indeterminately low,” he says. 
 
As regulators tighten the screws on banks, Rhode adds, they move risk from one part of the market to another. Institutional asset managers have absorbed dealer inventories as well as billions of dollars of newly-issued bonds. Net asset values will plummet once interest rates increase. The buy-side will have to cope with significant liquidity risk challenges when it comes to managing their fixed income portfolios on an active basis.
 
“Risk is like energy. It is being transferred in today’s markets, not destroyed. The buy side is driving the debate on how to trade bonds away from dealers and in alternatives to the OTC market,” he explains in a TabbForum video interview.
 
Tabb interviewed 24 corporate bond dealers over the third quarter 2012. Two-thirds were banks, the balance were agency dealers. Participants were split evenly between traders, business heads and e-commerce executives. Nearly 75 per cent were US-based, the rest European. 18 firms had global operations. Dealers were asked about their strategic advantage, challenges and attitudes toward regulation and how it will affect them in terms of capital, sales and trading, technology and resources.
 
Key findings include:
 
•         Only 40 per cent of dealers are committed to running global fixed income operations.
•         As the dealer inventory model wanes, asset managers need new liquidity sources to trade as they can no longer be beholden to a few dealers.
•         Balance sheet pressures are forcing dealers to keep block-sized trades on their books for shorter periods. On average, blocks are kept on books for a week or two compared to six months ago when it was anywhere between three weeks and three months.
•         Asset managers will increase their electronic trading in 2013 by 10 per cent to 32 per cent in notional terms and 4 per cent to 44 per cent in turnover terms.
•         Exempt from capital requirements and the Volcker Rule, hedge funds are expected to more than double their market share as market-making intermediaries, to 10 per cent from four per cent by 2014.

“OTC fixed-income markets are being shattered like a mirror, leaving corporate bond dealers to reflect on their role in a fractured, confusing mosaic,” Rhode says. “They can act either as an agent or principal, be global or regional, originate or distribute, prop trade or make markets, remain OTC or go to an exchange, invest in technology or hire more people, expand or retrench. Those with strong origination businesses can hide behind the primary issuance boom for now, but everyone knows – it’s a bubble and players have to examine their role in the secondary market.”
 

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