Trading At The Margin
October 05, 2012
Page 3 of 3
However, says BlackRock, corporate bonds’ overall liquidity continues to suffer as the market’s investment bank dealers, the traditional middlemen of the sector, cut their inventories in response to increasingly burdensome regulatory and capital constraints.
“The [corporate bond market’s] liquidity is bunched up in large new issues,” says BlackRock. “Poor liquidity is depressing overall trading—even as yield-hungry investors bid up prices and companies take advantage of historic low financing rates by issuing more debt.”
The firm is attempting to provide its own solution to the liquidity problems created by the withdrawal of investment banks from the corporate bond market, recently testing a new bond trading platform to allow traders to “cross” orders with each other or to match trades against BlackRock’s own internal order flows.
However, the platform’s details remain sketchy, and BlackRock declined repeated requests from IndexUniverse.eu for an interview with the firm’s head of bond trading, Richard Prager.
Other asset managers may set up a competing version of a centralised bond trading venue, according to a June report in the Wall Street Journal, possibly in conjunction with investment banks.
The increasing concentration of bond trading in a few selected corporate names may cut both ways. On the one hand, it allows ETF prices to be set on the basis of the marginal pricing of the most liquid index securities, permitting secondary market ETF traders to set wafer-thin bid-offer spreads in funds like HYG and JNK during an average day’s trading.
HYG, for example, often trades in the secondary market with a bid-offer spread of 1-2 cents on current fund price of around US$92, compared with an average bid-offer of 100 basis points in the underlying bonds.
But in a stressed market, the dislocation potential may increase. State Street told IndexUniverse.eu that while a typical bond ETF creation or redemption may be the result of a negotiation with its APs, it has the final say over what comes into or what goes out of the fund.
An unintended consequence of this may be that, during a period of rapid redemptions, APs will end up receiving bonds they hadn’t requested, potentially driving ETF secondary market prices down very quickly.
“If traders suddenly start receiving less liquid bonds from the ETF, such a scenario would accelerate moves to the downside,” says FT Markets Advisors’ Tchir. “Dealers wouldn’t have the luxury of saying to the ETF issuer, ‘I don’t want to buy these bonds’.”
Bond ETFs have undoubtedly been a huge success and may even have transformed the corporate bond markets, in the recent words of iShares. But it’s debatable whether they’ve done anything to improve the market’s deteriorating underlying liquidity, or whether they’ve merely shifted trading activity into a small subset of index names.
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