In a Morphing Market, No Fixed Outcome for Fixed Income

The U.S. Securities and Exchange Commission disbanded a panel of industry advisers whose recommendations on improving trading in the world’s largest stock market largely landed with a thud.

The SEC summarily disbanded the Equity Market Structure Advisory Committee in an email to members Wednesday after its recommendations "landed with a thud." The committee, formed in 2015 and comprised of 17 industry executives and academics, counted the proposed maker-taker pilot among its recommendations.

With equity market structure perfected, the SEC is turning its attention to bonds. Thursday's inaugural meeting of the Fixed Income Market Structure Advisory Committee featured discussion of key trends reshaping bond markets: new buy-side players' displacement of big banks as liquidity providers; the concentration of liquidity in bigger bond issues; and electronification.

The value of corporate bond markets has grown from $5.9T in 2010 to $8.1T in 2016. Even so, liquidity has dwindled as regulations have forced banks to curtail their market-making activities.

Bond trading revenue for the top twelve investment banks fell 26% from 2012 to 2016, with some analysts predicting another 20% drop this year.

Buy-side firms have partially stepped into that void. And nimbler trading firms like Citadel and Jane Street that began as prop shops have repurposed their infrastructure to provide comparatively fast, cheap fixed-income market-making services.

But in the absence of regulatory relief, traders have also adapted their strategies organically by homing in on pockets of liquidity. For example, they have increasingly gravitated to the most liquid bond issues.

Electronification can make such pockets easier to identify. Buy-side giants BlackRock and Vanguard announced at the meeting that they aim to electronify all of their bond trading by year end -- an approach that would help them more efficiently pool and match their trades with what's available in the marketplace.

What regulatory changes to fixed-income markets could be on tap? For now, specificity in that area seems to be in short supply. SEC chair Jay Clayton, who has voiced a desire to streamline bond markets, entreated committee members to focus on "'the long-term interest of the retail investor.'"

Mr. Clayton's statement may signal that the SEC will prioritize initiatives that reinforce current trends by streamlining bond markets for investment managers like BlackRock and Vanguard over tweaking regulations to restore banks to their former stature. Those efforts are clearly in an exploratory phase, however.

One model for the SEC's initiative could be bond market structure reform in Europe, where MiFID II regulations mandate greater transparency in bond trading. While compliance is exhausting firms' innovation budgets in the near-term, the coupling of electronification and AI to analyze bond trading data could unlock major efficiency gains in the next 2-4 years.

That transformation is likewise gaining steam in the U.S., where providers like Bloomberg, Liquidnet, MarketAxess, Tradeweb, and Trumid are launching data and analytics products to provide cheaper, automated pricing of corporate bonds.

Regulators will have their hands full coaxing efficiency out of a rapidly morphing fixed-income landscape while minimizing the risk of market meltdowns. While details remain sketchy, they seem intent on pressing forward rather than reviving old ways.


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