The considerable and growing interest among investors, issuers, regional broker/dealers and other market participants in a centralized order-driven liquidity mechanism is a manifest element of that natural selection process. Research indicates that such a neutral facility with full pre-trade and post-trade transparency — where all participants are equally empowered to access and offer liquidity and anonymously make markets — would materially increase liquidity and reduce transaction costs and market volatility.
“Nature abhors a vacuum.” ―Aristotle
The growing liquidity vacuum in the corporate bond market is the result of a number of causes, including the market’s exclusive quote-driven OTC structure. While economic and regulatory pressures have diminished the capacity and appetite of dealers to source liquidity, whether obligated or opportunistic, the market’s singular quote-driven model precludes institutions with deep resources of alternative price-sensitive liquidity from directly filling that void.
Benefits abound in a centralized order-driven market, where all transactions are negotiated and settled anonymously. Institutional investors seeking higher yields, including those that traditionally buy and hold, could provide liquidity and profitably make markets in securities they hold. This model would also better position brokers and dealers to access and source liquidity and make markets with lower capital constraints.
The Growing Thirst for Innovation
“Innovation is the central issue in economic prosperity” ―Michael Porter
The author also cautions that "corporate bonds are not standardized” and "the core elements to successful CLOB trading are not present in the marketplace." That isn’t so. In fact, corporate bonds are better suited to anonymous matching than stocks, and those required core elements are already in place and poised for interaction.
Stocks are not readily fungible instruments and their trading requires exact matching of the potential counterparties’ interests (e.g., the likelihood of a seller of Stock A and a buyer interested only in Stock B matching is remote). Corporate bonds, however, are well-suited to standardization and grouping due to their unifying characteristics (coupon, maturity, rating, issuer, duration, convexity, etc.).
This homogeneous nature of congruent issues accommodates their relative pricing based on yield-spreads to more liquid instruments and optimizes the number of potential transaction counterparties. Rather than seeking a specific CUSIP, prospective bond buyers are generally interested in any order offering an issue that meets their desired characteristics and price/size requirements. Thus a transaction occurring between a buyer and one of an array of competing sellers (and vice versa) is much more likely.
The Coming Diversity of Options
“A horse never runs so fast as when he has other horses to catch up and outpace.” ―Ovid
History demonstrates that when multiple delivery models fairly compete, innovation and efficiency increase and the market benefits from that diversity. The number and diversity of available liquidity models in the corporate bond market will inevitably, and likely soon, increase.
Extensive informal polling of institutional investors indicates the most compelling model would be a fully transparent, order-driven network operated by a regulated, neutral third-party, through which all participants equally and anonymously:
Interact with an array of competing liquidity platforms and providers in both the primary and secondary market; and
Access and source liquidity and opportunistically make markets.
Most respondents also indicated that such a regulated market would likely:
Reduce transaction costs and elevate the Topic 820 classification of corporate bonds;
Promote investor and regulatory confidence;
Facilitate more effective and dynamic risk management; and
Assure every market transaction is executed at the best price, regardless of where the trade occurs.