In a world in which everything from groceries to exclusive photographs of the Beatles can be exchanged with a few clicks, the complexity of buying and selling corporate bonds is an enduring, and frustrating, anomaly.
The majority of bonds still change hands when a bank like J.P. Morgan or Morgan Stanley puts up some money to back the transaction. Before the financial crisis, banks had plenty of money to do that. But since then, regulators around the world have tried to curb banks’ risk-taking. They’ve been successful in reining in dealers, but in doing so regulators have broken the trading models for corporate bonds at the same time.
“Market structure isn’t working,” says Anthony Perrotta, head of fixed-income research at TABB Group. The Westborough, Massachusetts-based financial services consultancy hosted a half-day conference on trading in corporate credit, derivatives and rates last week in New York.
But markets are dynamic, and ideas to fix them are flourishing, even if many are still embryonic. Electronic trading is part of the answer. Last year electronic trading platforms accounted for about 50 percent of overall activity in over-the-counter derivatives, up from just 10 percent the year before, according to Lee Olesky, CEO of Tradeweb Markets in New York. That increase came after products were standardized and regulators mandated more use of electronic services.
The bond market is different, though. Companies still issue hundreds of different corporate bonds, each with quirky terms and usually different interest rates. General Electric Co., one of the most active issuers, has 1,014 individual bond issues outstanding, according to Barclays and Bloomberg data. And regulators have not intervened in corporate bonds. Only about 20 percent of corporate bond trading occurs electronically, mostly involving smaller deals.
Liquidity — the ease with which bonds can be traded — is a bigger concern for money managers than the health of the markets now. Michael Buchanan, head of global credit at Pasadena, California-based Western Asset Management Co., says the majority of investment-grade bonds — about 70 percent — account for less than 10 percent of all trading. The prices on those inactive issues move erratically. “It makes managing a credit portfolio in a dynamic fashion more challenging,” he says. One of the unintended consequences of illiquidity is that smaller companies, whose issues get hit the hardest, may ultimately pay a lot more for financing as a result.
Standardizing bond issues could help electronic trading, but companies aren’t lining up to do it. Companies like the flexibility of issuing at different rates of interest, investors might want specific call provisions on particular issues, and underwriters have a big interest in preserving the status quo.
“It’s healthy to have that conversation, but it’s not just the underwriters; it’s the companies themselves,” says Kevin Corgan, head of North American credit trading at J.P. Morgan. “What we’ve heard is there is very little desire from the companies to issue standardized bonds.” He notes that companies could be motivated to standardize issues if the market rewarded them with better rates. But until there’s a test case, it’s hard to predict whether that will happen. Buchanan says it’s difficult to standardize features like covenants, which offer protections for investors.
Despite regulations, banks are moving ahead with fixes themselves. J.P. Morgan created a global index trading team and has hired more people to support turnover in single-name credits. “We think about liquidity daily. There are many new e-trading platforms which we’re evaluating — and in some ways it’s an experiment to see which will succeed and help improve liquidity,” says Corgan.
Help can’t come soon enough. According to BlackRock, newly printed bonds trade actively, but within just four weeks of issuance, trading volume plummets by about 50 percent and keeps dwindling.
As a result, money managers are thinking differently about how to manage their portfolios. Western Asset assumes it will be holding certain issues until maturity. Although eBay has introduced “liquidity” into the market for things like rare antiques and even old LPs, it’s still hard to find a buyer or seller of bonds of even some well-known companies. “We can’t rely on being able to trade out,” says Buchanan.
Get more on fixed income.
Follow Julie Segal on Twitter at @julie_segal .
