There are changes coming in the future to bond trading. And, the change is going to be connected with electronics.
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“Electronic dealing” has come to stock exchanges…and to foreign-exchange trading. Can electronic bond trading be far behind?
Foreign-exchange trading has increased tremendously in recent years but has followed the lead of stock-trading.
To show how the world is changing, lets look at information provided by Aite Group, LLC, a Boston based consulting firm that has reviewed data provided by the Bank for International Settlements. Aite states that in 2013, 66 percent of all currency transactions were done through electronic dealing. This is up from only 20 percent in 2001.
Furthermore, Aite claims that this kind of trading will rise to 76 percent within five years. Spot trading—the buying and selling of currency for immediate delivery—will amount to “about 81 percent” by 2018.
Bond trading is moving in this direction but very slowly.
Currently, Tracy Alloway and Michael Mackenzie write in the Financial Times that bond-trading platforms “account for only about one percent of market share.” Not very much activity.
Yet Goldman Sachs has been developing a bond-trading platform as have BlackRock, Morgan Stanley and UBS.
These organizations have stock trading platforms and foreign-exchange trading platforms, but they have not moved very rapidly in the area of bond trading. There are several reasons for this.
One problem is that bonds come in many maturities and types. This makes them more difficult to trade electronically. Furthermore, the banks don’t hold as many bonds on their balance sheets as they once did, causing for an increased need to search for what a buyer wants.
In addition, for years, bond trading has been one of the biggest profit makers for Wall Street.
Also, bond trading has tended to be proprietary and information in the market is not shared in the way it is in other markets. Institutions just don’t like giving up information that they believe gives them an advantage.
Alloway and Mackenzie also state that “”large trades in bonds remain dominated by voice-brokered transactions.”
Furthermore, the trading platforms that the large institutions mentioned above have created are bank-run “single-dealer” platforms. The reason for this is that the banks want to continue to control the part of the trading-game that they are active in. That is, these banks have just tried to extend the way they do business without the electronics into the “electronic dealing” space.
It is reported that these “single-dealer” platforms have been given a “thumbs-down” vote by big investors and this is one reason why the current efforts to create a electronic bond trading world has not succeeded to any degree.
Consequently, the belief is that this will force banks to move to “multi-dealer” platforms that would include most of the big organizations dealing in bonds these days.
But, moving in this direction would reduce the opaque-ness of the bond market and result in much less revenue from the bond-trading business.
In addition, a movement into more “electronic dealing” in the bond market would also reduce the number of players that would be able to play in the bond markets. Moving to electronic, multi-dealer trading platforms would place a greater emphasis on the scalability of the platforms and reduce the ability of the smaller investment firms to be a part of the system.
The earlier article about electronic foreign-exchange trading describes how these things have happened over time in the foreign-exchange markets. The markets have become more transparent, the smaller players have not been able to participant in the market and so have dwindled in number, and margins on trades decline substantially
And, there is one other factor that happens as electronic trading spreads. To quote from the first article cited above, but applying it to bond-trading rather than foreign-exchange trading. The move by banks into electronic trading in other areas has cost a large number of jobs….”
Of course, “the push toward electronic trading probably will lower costs for customers and boost transparency of pricing.”
But, as with other types of business in the financial world, electronic finance is expanding every day and will, one day, become ubiquitous.
Right now, the “banks” are just protecting their “space” as much as they can. However, competition is going to drive the market…again just note that Goldman Sachs, Morgan Stanley, UBS, and BlackRock are already playing in the space…and regulators continue to push to create openness and transparency in transactions and limit as much as possible “single-dealer” markets.
The pace of change is always an unknown. However, as with most technologies, the speed of transition to the new world just goes faster and faster and faster and moves into more, and more complex transactions.
But, the beat goes on. Frankly, I have been surprised by how slowly mobile banking has come about. Yet, I see the use of mobile banking speeding up every day…right before my eyes.
My bet for the future is that most transactions…banking, trading, and so forth…will all be capable of being handled on a mobile device without the need for dealing with a real live person, within the next five years. And, it could be much sooner than that.
About John Mason
John has been the President and CEO of two publicly traded financial institutions and an Executive Vice President and CFO of a third. He has also spent time as an economist in the Federal Reserve System and worked for a cabinet secretary in Washington, D. C. In addition John taught in the Finance Department at the Wharton School of the University of Pennsylvania for ten years. He now currently has a column on the blog Seeking Alpha and is ranked number 3 in terms of readers on the economy. From this column, two books have been published this past year from earlier blog posts. John is active in the shadow banking world, the venture capital space, and in angel investing. Other than that John works with start ups and early stage organizations, for profit and not-for-profit.
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