Electronic bond trading stalled in volatile markets

Bid/offer spreads on bond platforms spiked in March and the buy side struggled to trade

Electronic-trading-breakdown-left-buy-side-floundering

Corporate bond trading volumes soared in March, as panic over the impact of coronavirus sparked a flurry of investor activity. But the proportion of bonds traded on two main electronic platforms shrank. Buy-side traders say banks withdrew from the venues during the volatility, making price discovery an even harder task than usual.

“Electronic trading saw a breakdown in functionality during the height of the volatility spike,” says Jason Fromer, head of US trading for fixed income, currencies and commodities at Manulife Investment Management. “Corporate bond trading sell-side algos seemed to shut down during the height of the volatility. Electronic response levels decreased, and bid/ask spreads widened significantly to untradeable screen levels.”

Data on Trace, which collects information on US corporate bond trades from US regulated firms, shows record volumes for high yield and investment grade bonds in March. Two of the main electronic trading platforms for bonds, MarketAxess and Tradeweb, saw record volumes in US credit.

But despite the volume surge, a lower proportion of trades went through the two platforms. Their combined share of investment grade and high yield trades fell from 29.5% in February to 28.1% in March, as a proportion of total volumes visible on Trace. Comparisons come with a caveat, as each platform reports a slightly different amount for Trace activity.

The overall decline masks variations between the two platforms, though. Tradeweb saw its share of US investment grade trading decline from 16.2% in February to 12.8% in March, while MarketAxess saw its equivalent figure rise from 19.5% in February to 20.6% in March.

 

The platforms enable users to trade corporate bonds via request-for-quote (RFQ), and some market-makers use algorithms to automatically generate quotes.

But a rise in volatility during March disrupted trading, say buy-siders. At the peak of the volatility on March 23, bid/offer spreads – an indication of market volatility and transaction costs – on US high grade credit were 12 times wider than their daily January average, according to data from MarketAxess.

A fixed income trading head at a European asset manager says many banks stopped auto-quoting bonds on the platforms during March, making it hard to determine pricing.

“With sell-side traders working from home and the auto-quotes being turned off it was very difficult to get prices. That is improving now – not back to normal but we are getting more quotes back on the platform,” the head says.

A fixed income trader at a second European asset manager says liquidity on electronic trading platforms was “virtually nonexistent” at the height of market volatility, although trading conditions quickly improved after the worst of the disruption.

He says quotes were at times hard to come by, frustrating execution and exacerbating poor liquidity conditions. Inconsistent quotes made trading a “smoke and mirrors exercise”, he adds.

The banks that continued to auto-quote did so at unusable prices: “If sell-side pricing machines weren’t turned off in that first three-day period, they were certainly tweaked to the point where the prices were not acceptable. Our behaviour changed quite a lot because we were no longer able to rely on the fact that we had access to multiple pricing points,” he says.

 

One sell-side fixed income senior manager argues banks were not solely responsible for the breakdown in electronic trading during March, and says the buy side’s own execution tools may not have been adaptive enough to allow them to trade during the uncertainty.

Buy-siders that were likely to struggle were those who were unable to adjust their parameters of automation, the senior manager suggests. Conversely, traders fared better if they could amend conditions such as the number of quotes needed and the quote’s difference from a platform’s composite price.

“If clients were making the tweaks themselves, they were very quickly able to change those criteria to be able to continue to manage automating at least a smaller number of tickets. It definitely brought forward the fact that the buy side needs to be able to control these tools a little bit more dynamically themselves,” says the senior manager.

Daniel Leon, global head of trading, security financing and derivatives at Axa Investment Managers, says the fall in liquidity on electronic trading platforms was simply an extension of difficulties in the wider markets.

“The platform will be a reflection of liquidity in the rest of the market. It is not about electronic versus non-electronic,” he says.

Buy-side trading desks should use their own analytical tools and methods, like access to bank axes, to monitor liquidity conditions, without relying solely on platforms, he adds.

A tale of two platforms

At Tradeweb, fully electronic trading activity fell, with volumes executed completely on the platform representing 3.8% of US investment grade credit in March, down from 7.4% the month before. But in both high yield and investment grade, the proportion of Trace transactions that were electronically processed on the system rose slightly from February.

Chris Bruner, head of US credit at Tradeweb, says those using the platform to process and hedge voice trades “wanted to make the trading process as safe as possible” and maintain the typical workflow.

 

At MarketAxess, roughly half of Trace-reported US investment grade volumes for March that passed through the platform were executed on its all-to-all system, Open Trading, which facilitates buy side to buy side trading in addition to traditional buy side to sell side.

Buy-side RFQs that were displayed across the whole platform but answered only by participants on the all-to-all system grew significantly in March, notably for European bonds, MarketAxess data shows. Open Trading quotes also won more often than usual, suggesting buy-side participants increasingly turned to alternative sources of liquidity as market conditions challenged traditional dealer-to-client trading.

When it comes to automated trading, Tradeweb says it’s seeing the same number of users automating, but not at the same levels they were previously.

Speaking in late March, Charlie Campbell-Johnston, head of workflow solutions at Tradeweb, said: “Algo-based RFQ responses in the credit space have been somewhat curtailed in the last couple of weeks. They’re still auto-quoting, just not necessarily in the widest range of bonds in the sizes that they were doing two or three weeks ago.”

Patchy markets

The drop-off in liquidity hit a market that was already struggling to find it.

In credit markets, especially, trade automation and use of electronic platforms varies by order size, with some banks pricing and automatically executing smaller, so-called odd lot trades while leaving the larger tickets to the voice desks.

While many market participants say they’ve seen increased liquidity in these smaller fixed income trades in recent years, more than half of the buy side say overall liquidity in European fixed income has deteriorated in that time, according to a 2020 survey by the International Capital Market Association, an industry group.

The decline is especially apparent for larger trades. Roughly a fifth of buy-side respondents reported deteriorating liquidity for trades €1 million ($1.1 million) or less, but around two-thirds bemoaned the liquidity conditions for trades €10 million and larger.

For some, March’s volatility exacerbated these already strained conditions. Others view the market’s challenges as a reason to embrace technology. The sell-side fixed income senior manager says the period highlights the need for automation in fixed income markets. With smaller tickets handled by machines, voice traders would be free to price and execute the larger, more illiquid orders.

Swaps suffer liquidity squeeze

Along with bonds, rates products suffered trading disruption on electronic platforms during March. US rates volatility spiked on March 19, according to a Cboe index based on US dollar swaptions pricing. The peak was 31% higher than January’s average daily measure. Fifty-seven percent more interest rate derivatives passed through Tradeweb in March than the 2019 monthly average.

But a rise in volumes doesn’t always equate to a rise in liquidity, or how easily traders can move in and out of positions at prices they deem fair, with buy-side traders reporting difficulties in transacting interest rate swaps on platforms.

A trading head at a third European asset manager says bank counterparties asked the buy side to limit their use of electronic platforms, meaning in some cases they would have to revert to voice execution for interest rate swaps.

“We did keep on using those algorithms that didn’t give us any issues in terms of trading. But we were also forced to accommodate banks’ requests and switched from pure algo and automation systems into more traditional voice trades,” the trading head says.

Banks’ caution meant they were slower to respond when asked for swaps and swaptions quotes, says Joost de Bakker, a trader at Cardano, a Dutch and UK investment manager.

“That's probably also because market inputs were less reliable and more volatile,” he says. Cardano has continued to trade most of its swaps off electronic platforms.

For some, the resulting market illiquidity in March calls into question the usability of electronic trading for certain asset classes.

“We pretty much stuck to voice-only trading for interest rate swaps and we didn’t touch any of the electronic platforms,” says Michel Lansink, head of trading at Cardano. “Electronic trading platforms are of help for certain categories, foreign exchange for example, but in other categories like interest rate swaps it is not the go-to route in these stress market circumstances. Relationship and voice trading is really of essence to get trades done.”

Correction, May 1, 2020: This article has been changed to clarify that MarketAxess’s Open Trading system accounted for roughly half of the platform’s Trace-reported US investment grade bond volumes in March.

Editing by Alex Krohn

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