Fixed-income markets could come to more closely resemble equity markets, according to a new report from Greenwich Associates.
In its report, Greenwich says that the transformation of fixed-income markets from a very dealer-oriented model to something more closely resembling equity markets, with much more transparency and agency trading, could come as a side effect of new capital rules and other post-crisis reforms.
“Changes to global fixed-income markets — and in particular, strict new capital reserve requirements imposed on banks — have set the stage for a far-reaching transformation,” it says.
While this is a largely unintended consequence, Greenwich says that reforms to make the financial industry safer is also making the business of fixed-income dealing less attractive to the firms that are central to the existing market structure. “The resulting pullback on the part of dealers has already had a negative impact on market liquidity, and could reduce liquidity to the point at which the types of electronic trading venues typical in equity markets become viable alternatives for investors,” it says.
At the same time, ongoing reforms of derivatives markets, specifically the move to central clearing, will make derivatives markets more standardized, and more conducive to equity-style trading, it notes.
“Prior to the global crisis, investors were accustomed to having their trades cleared in full by individual dealers that maintained huge inventories,” explains Greenwich Associates, consultant Tim Sangston. “After the sell-side retrenchment caused by the crisis, we saw much more dealer-driven crossing, both on an internal basis among clients and in terms of dealers teaming up to process individual client trades. The next logical step is crossing between and among investors.”
Electronic platforms are a natural fit for this sort of trading, Greenwich says, but currently they account for just 25% of overall fixed-income trading. Looking ahead, Greenwich predicts that, “As investors seek out alternative sources of fixed-income liquidity and central clearing becomes standard practice in derivatives trading, we expect electronic trading volumes in the U.S. fixed-income market to begin moving gradually in the direction of those now seen in equities.”
For dealers, it foresees thinner margins, increased transaction flow, increased investment in electronic bond trading platforms, and increased competition. But, investors should enjoy reduced costs and increased transparency, ultimately leading to a new client base for dealers, it suggests.