“Fixed-income markets are approaching a critical stage in their evolution,” said Anthony Perrotta, chief executive officer of the Tabb Group, at the opening of the Fixed Income 2018 Evolutionary Tipping Point conference in New York recently.
He said the fixed-income markets are besieged on all sides and struggling to find the proper balance between a demand for efficiency and dependency on principal-based risk transfer. Ten years removed from the credit crisis, fixed-income markets are larger, less liquid, and increasingly fragmented. While market structure reform threatens, so far debate has trumped substantive change.
The Tabb Group, an international research, advisory and consulting firm focused on capital markets, hosted the conference. Perrotta told the assembled group of fixed-income industry insiders that the time to act is now.
Perrotta revealed the results of a survey of 1,500 asset managers, which said that 80% have traded a corporate bond electronically.
Other results from the survey were:
- Liquidity in U.S. corporate bonds is not a problem, until it is.
- Balance sheet capacity is now concentrated in the hands of five or six U.S. banks.
- Dealer liquidity has fallen 2.5 times since the financial crisis of 2008.
- Immediacy is still below 2006 levels but also concentrated with five or six banks.
- Riskless principal trading while leveling off is still prevalent. The amount of riskless principle trading is 13%.
Medium-sized and small banks have reduced the amount of capital in the market place. In addition, the large European banks, with the exception of one, have reduced their balance sheet exposures.
The survey said that the amount of capacity that exists relative to the size of the marketplace has fallen by a multiple of 2.5.
The survey also said that the liquidity of the U.S. Treasury bond market is becoming increasing concentrated. Overall, U.S. Treasury capacity has declined 50% since the fiscal crisis, while actual U.S. Treasury holdings have risen. The top five dealers and secondary marketers for users commit an average of 2.5 times more capital to clients’ market share, and this is increasingly getting more concentrated.
“Top five providers in the marketplace are all U.S. banks,” said Perrotta. “What that tells me about the U.S. bond market is that liquidity is becoming concentrated.”
According to investor responses. U.S. banks dominate with few exceptions. Banks are getting more market share, which they should be happy about. But, at the same time, they realize this is an unhealthy market issue where liquidity is concerned.
So where is market structure headed?
U.S. markets are dominated by the principal risk model, which ultimately means that investors rely on third party capital for risk transfer. However, until the macro structure of the market changes no solution will be a panacea for illiquidity and the price for liquidity will continue to rise.