Platform Proliferation: Déjà Vu All Over Again?

We’ve borne witness to this scene before – necessity stirring the entrepreneurial zeal of electronic trading innovators. Many platforms stepped forward; few survived. Back then, the market’s message was clear: Solve a problem, or die trying. Given that the current issue facing everyone may be rooted in market structure, today’s innovators have their work cut out for them.

The development of the internet ushered in many innovations. In financial markets, the technology paved the way for the proliferation of electronic trading and the rise of platforms. For fixed income, in particular, more than 85 alternative trading systems (ATS) and electronic communication networks (ECN) were introduced, utilizing both multi-dealer (MDP) and single-dealer (SDP) concepts servicing institutional dealers and investors.

As quickly as these entrepreneurial ventures arose, many were eradicated in a few short years, leaving a core group of participants to solidify franchises that persist through today. Many of the platforms that avoided the purge did so by solving a clear and obvious problem – a seemingly important requirement when wanting to perpetuate a business. Platforms wanting to garner favor with investors are wise to be particularly focused on this salient point.

Many things have developed out of the wake of the financial crisis, but the one persistently capturing the attention of market participants and the media is the dearth of liquidity. As such, alternative sources of liquidity have become all the rage. This has precipitated a renaissance of sorts in the electronic trading space across fixed income markets.

In the U.S. corporate bond market, liquidity issues have been exacerbated by the changing regulatory environment, the growing weight of assets under management (AuM), the reduction in on-demand trading that dealers provide, and the inherent lack of homogeneity. The days of immediacy (at least, for larger trades) and the unabated use of dealer balance sheet are seemingly gone. Investor appetite is being satiated by a relentless flow of new issues. But illiquidity still pervades 98.5% of the secondary market. The ratio of dealer liquidity (as defined by the capital large banks commit to secondary market-making in IG and HY markets) has fallen from 2.3% to just above 1.2%, a 48% decline.  

Execution venues are busy introducing trading protocols purporting to solve the problem. MarketAxess currently owns most of the electronic market share (about 15% of the total market), but the solution it provided in 2002 (the list-based, electronic request-for-quote, or “e-RFQ”) facilitates cash flow trades requiring immediacy. These tend to be odd-lots (TABB estimates the average e-RFQ to be approximately $480K). The real problem beguiling the market is the inability to move off-the-run issues (approximately 24,000 outstanding CUSIPs) for notional trade sizes greater than $2 million.

It has taken several years to get new platforms to the deployment stage, but competition finally is developing. Imbedded institutional fixed income platforms such as Tradeweb and Bloomberg are now being joined by upstarts such as TruMid, Electronifie, and Bondcube. Retail ATSs such as KCG Bondpoint and TMC Bonds are diversifying their models, offering connectivity to large asset managers. Established equity trading venues such as Liquidnet and ITG are also getting into the game, as are European platforms including MTS/Bonds.com. In total, there are almost two dozen trading platforms or electronic models servicing the corporate bond landscape, jockeying for market share.

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