There's been a role reversal in the corproate bond market as dealers are not benefiting from market opaqueness as they once did.
The advent of Basel III and the Dodd-Frank Act has changed the market's dynamics. Legislators and regulators continue to use everything in their bag of tricks to force dealers to deleverage their balance sheets. As a result, asset managers are now warehousing corporate debt while the sell side has jumped into an agency business model with both feet.
However, the buy side has decided not to adopt the role of price maker as shown by the healthy crop of all-to-all markets that have popped up in the past few years.
Whether it is a matter of what a fund's charter will allow or the simple desire not to take on that risk, asset managers still look to dealers to make prices, which seems silly considering asset managers have a better sense of what is happening in the bond market than dealers do.
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A few weeks ago, Graham Giller, head of data science research, CIB Data Science at J.P. Morgan, shared a conversation he had with a credit trader from his firm about a year ago who said that they did not know the price of things.
"This is not forecasting into the future; this is not a clever alpha generation; this is not train following or reversion strategy," recounted Giller during his presentation at the Big Data Finance Conference in mid-May. "This is what the price is now. The last time this bond traded was a week ago, and I do not know what it ought to be."
It is a scary thought that one of the largest dealers on The Street has difficulties in pricing its trades, but should not come as a big surprise.
Dealers no longer can rely on their inventories to know how easy it will be to fill a client's order and price that into their quotes. The sell side is left relying on the same market data that is available to the buy side.
On the other hand, asset manager can get quotes from multiple dealers and get an aggregate picture of how issues are trading. Just look at AllianceBernstein, which developed its Automated Liquidity Filtering Analytics platform for bond trading that aggregates feeds from several electronic trading venues as well as dealer inventories prior to selling it to Algomi in May.
Access to such rich market data makes it easy for asset managers to become a price maker, but the platform is more of the exception rather than the rule for the buy side.
As long as the buy side continues to rely on dealers for price making, the dealers need to find a better and a more transparent way to price their quotes for the health of the market.
