The Corporate Bond Market is Undergoing Radical Transformation, Says TABB Research

Buy-Side Corporate Bond Portfolios at Risk as Dealers Examine Future Role in OTC Fixed-Income Markets; New Markets and Trading Protocols Seen Emerging

NEW YORK & LONDON--()--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.” At the very core, banks are re-evaluating their role in a market they’ve dominated, dictated and designed for over 50 years. But today, returns are lower, costs and risks are higher. They are looking at how to realize efficiencies, adopt new business models or exit the industry entirely.

According to Will Rhode, TABB’s director of fixed income research and the study’s author, banks have reported fixed income losses of $8 billion 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.”

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 (NAV) 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% 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% 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% to 32% in notional terms and 4% to 44% 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% from 4% 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, who sees little consensus on the best business model for the future. “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.” On the upside, he adds, “new marketplaces and trading protocols are emerging.”

The Executive Summary for this 36-page study with 43 exhibits is available online at TABB Group. Research Alliance Fixed Income clients and qualified media can download the study now at www.tabbgroup.com. For more information or to order the report, write to info@tabbgroup.com.

About TABB Group

With offices in New York, London and expansion to Asia-Pacific, TABB Group is the only financial markets research firm focused solely on capital markets, based on the proven interview-based research methodology of “first-person knowledge” developed by founder Larry Tabb. For more information, visit www.tabbgroup.com. In January 2010, TABB launched TabbFORUM, the online global capital markets community covering analyses of current issues, tracked daily by over 14,000 professionals.

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martinrabkinink
Martin Rabkin, 914-420-5739
mrabkin@martinrabkinink.com

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The Corporate Bond Market is Undergoing Radical Transformation, Says TABB Research

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Contacts

martinrabkinink
Martin Rabkin, 914-420-5739
mrabkin@martinrabkinink.com