Asset managers are focused on the overall liquidity in fixed income markets in general, and corporate bond markets in particular.
“Banks have to maximize the profitable use of their balance sheets in a more closely managed process than they have had to in the past because of regulatory requirements impacting their business model,” said John Griffin, senior risk manager at The Hartford Investment Management Company (HIMCO). “Buy-side institutions are very closely watching how that impacts the liquidity we seek in primarily the investment grade markets. Structured credit is going to be impacted as well, but you don't expect to always have the liquidity there like you do in the primary IG issuances.”
Banks are taking “a very productive but stern look at how they manage their balance sheet utilization,” said Griffin. “Banks are trying to get ahead of the Basel III requirements before they actually become mandatory and have made great progress overall. Between the Volcker rule and Basel III, banks might not be in a position to provide the historically liquid markets that we’ve come to rely upon them for. That's bringing up an interesting conversation of, do buy-side firms start trading with buy-side firms, to try and fill that liquidity gap? Liquidity is the most interesting topic we’re facing as an industry.”
Risk management at all levels—pre-trade, desk position and enterprise-wide—is vital for both regulatory necessity and business profitability. “The requirements of the CFTC and ESMA in cleared and electronic markets are now well understood and supported by most vendor products,” said Tim Dodd, head of product management for SunGard’s Front Arena, in a blog posting. “The greater challenge lies at the enterprise level, where overall house (and, ideally, client) positions should be managed in as close to real time as possible. In the bilateral space, where credit and liquidity risk are still the key factors, an enterprise-wide view is equally important.”
As for the credit markets, “there's been talk in the industry about more or new electronic platforms opening themselves up to enable buy-side firms to trade with each other as well as the traditional dealers,” said Griffin. There's been talk of it over the years, but when banks were making very liquid markets, you didn't really need to. Now, with some of the changes we're beginning to see, there may be a place for the larger asset management firms, even hedge funds, to open up trading to each other on some of the electronic platforms that have been used in the past for treasuries and corporates, and have now morphed into swap execution facilities.”
As more trading in derivatives is mandated to go electronic, the question is, does that drag cash more bond trading along with it? “Because you're now required to get more comfortable with electronic trading for certain products, this may have the effect of causing those same traders to figure they might as well be getting quotes for products traditionally transacted over the phone on one of the electronic platforms they’re now using for mandated products,” said Griffin.
From an asset allocation perspective, it's all about asset liability management. “In addition to the usual risk return profile of a trade, liquidity is playing a very important part in that discussion among portfolio managers as they manage cash flow requirements,” Griffin said.
