David E. Rutter, founder of LiquidityEdge and chief executive of R3, argues that now is the time to transform the corporate bond secondary market; bringing technology to bear on the twin challenges of fragmented liquidity and the risks of data leakage.
Disruption is a Catalyst for Change
David Rutter, R3
Economic disruption is a catalyst for change in markets. It exposes weaknesses in business models and market structures and highlights the strengths of solutions that rise to the occasion. It drives market participants to find answers with new urgency.
Today is no different. Recent market volatility has exposed challenges in the corporate bond secondary market which have hampered it for years. It has also shone a light on the answers to those challenges. Neither the challenges nor the solutions of the future can be ignored any longer.
Increasing investor interest in the corporate bond market in the current low rate environment has caused the cumulative notional outstanding value across corporate bonds to balloon. However, the market remains illiquid and inefficient, and price discovery is the number one challenge investors face today.
Voice and electronic platforms that facilitate the majority of trading volume have opaque price discovery mechanisms built-in, but investors must balance any attempt to acquire pricing information with the need to protect themselves from data leakage to the market. Alerting competitors to one’s intentions leads to price slippage and decreases execution quality.
Data and Privacy
Firms need reliable and accurate sources of market data to get a better sense of market conditions before they place orders. The market has seen and welcomed the arrival of many new data analytics and AI approaches to solve this problem, but nothing can be as sufficient as real prices from real orders in the market. This is difficult in an illiquid market.
However, trading venues today continue to identify data as a defensible source of revenue. Venues aggregate user-generated data and sell it at one price to all users, regardless of their contribution to the underlying data pool. There is something fundamentally wrong with this setup. Market participants generate data by submitting orders and executing trades. But rather than sharing in the revenue for real value creation, those same users are charged to consume the data feed.
Furthermore, the bar for confidence in pricing data and readiness to trade is high – execution today – especially for large orders – is time-consuming and difficult. Venues that push trades to the entire market ‘leak’ maximum data by design, RFQs show some data and are time-consuming to put together, and working orders on the phone – the chosen method for 70% of trades in a given day – still leaks data and is, of course, the most time-consuming trading method.
Some progress has been made, at least on the first of these challenges, over the last few years.
The Move to Electronic Liquidity is Incomplete
Spurred on by a need to decrease trading costs and a willingness to experiment with relatively small trade sizes, the corporate bond market has been adopting electronic platforms for over five years. This has opened an avenue for non-bank market makers to provide greater levels of liquidity. However, adoption has not met expectations. Just 30% of the market is now electronic and the largest tickets are still traded via voice brokers. 82% of traders say tickets over $15 million are difficult to trade on electronic trading platforms. This is partly because liquidity which is on electronic markets is fractured across a plethora of RFQ and all-to-all venues.
In the wake of recent volatility however, we’ve seen liquidity quickly retreat from electronic platforms. This is a clear indication that, during critical execution times, the current electronic models just aren’t providing a trading environment that traders can trust when times get tough.
The credit markets are not working for their participants and they won’t until we make radical changes to the way venues operate. Liquidity is fragmented; data is expensive and firms can’t guarantee best execution without risking data leakage. It is time for something new.
LedgerEdge
In my career, I’ve been involved in several technology-led revolutions in the way markets operate. From introducing the first wave of electronic trading at BrokerTech and EBS to helping to popularise all-to-all trading in US Treasuries with LiquidityEdge.
I believe that technology can again step in to solve these problems in the corporate bond market, which are mirrored in many other areas of the capital markets. Through my work as CEO of R3, I’ve seen how some of the world’s leading trading venues, including NASDAQ and the Swiss Stock Exchange, are embracing blockchain to improve their existing capabilities.
I believe blockchain can provide the corporate bond markets with a new model. One which puts users in control by providing them with control over their data. One which lets users access the value which they’re responsible for creating by rewarding them for providing liquidity, sharing anonymised data and adhering to good market practices. One which is built in collaboration with the institutions which it will serve.
Under the banner of LedgerEdge, we are now working closely with the industry to develop a platform which will allow firms to find liquidity and identify corporate bond prices without leaking information. By involving all sides of the market from the outside, LedgerEdge will ensure its platform is built by the industry, for the industry.
By David E. Rutter, founder of LiquidityEdge and CEO of R3
