Why Asia’s bond traders are heading online
Buying and selling bonds, especially corporate bonds, remains a largely old-fashioned business in Asia, even as the region’s stock of debt denominated in hard currencies continues to expand, with issuance so far this year at another record high.
At present, there is in Asia more than $1.4 trillion-worth of so-called G3 debt—that’s bonds denominated in US dollars, euros, and yen—Dealogic data shows. Yet many are held to maturity and a vast amount only trades occasionally.
Bankers that FinanceAsia, the sister publication of AsianInvestor, spoke to estimate that 90% of the Asian G3 bonds, both sovereign and corporate, trade less than five times a year.
However, things are changing; as more former price takers become price makers and demand for greater transparency grows under Europe’s Mifid II regulations, bond investors are increasingly being nudged onto online trading platforms.
“The Asian corporate bond market is following the trend of electronic trading in both the US and Europe, albeit at a more gradual pace,” said Niels Bouwman, a Singapore-based bond trader at NN Investment Partners. “Electronic trading will be increasing in the coming years. It is one of the ways for both buy and sell-side firms to reduce costs faster, better and cheaper.”
Around half of US government bonds are traded electronically, according to consulting firm Greenwich Associates. For corporate bonds the progress has been slower, with only a quarter of investment-grade bonds and 13% of junk-rated debts traded online. It’s even less in Asia, where around 5% to 10% of the market trades electronically, say bankers.
The migration onto electronic trading platforms appears inevitable, though, as more bond investors get accustomed to them. In an earlier Greenwich survey in 2016, more than 80% of US corporate bond investors said they had tried out electronic trading systems in some form—double what it was a decade earlier.
Some individual banks in Asia are also pushing ahead more aggressively. Deutsche Bank, for example, reckons about 30% of its own trading volume and 70% of tickets in Asia are traded electronically. That suggests banks are encouraging investors to use automated services to cut costs and free up traders for larger, more profitable transactions.
Manjesh Verma, Citi’s head of Asia credit sector specialists, said the “auto execution of trades is becoming a key theme for us and is likely to be transformative for the business over the next two to five years.”
“The initial focus is on improving the volumes that we trade with clients based on simple pre-set parameters,” Verma said. “But gradually we will be moving towards a system where risk-additive and/or risk-reducing trades will also be executed and prices adjusted accordingly as per trader defined instructions.”
Structural change
Behind this online shift lie some deeper structural changes to the market.
Proprietary trading at major banks has declined dramatically since the 2008 financial crisis, largely due to the introduction of the landmark Dodd-Frank act and rising capital costs. Goldman Sachs, once renowned for its trading prowess, reported a precipitous decline in its core fixed-income, currencies and commodities unit (FICC) this year. In mid-October the US investment bank posted a 26% decline in its FICC net revenues for the three months to September, after a rocky first-half of the year, as customers such as hedge funds traded less through them than in the past.
As tougher regulations weigh on the ability of banks to warehouse corporate bonds and make markets, investors such as asset managers and insurance companies are increasingly taking on the role. The secondary trading model has changed from “a sell-side to buy-side” model, where bond investors are quoted prices by traders at an investment bank, to one where the buy-side is more engaged in warehousing and trading risk.
The traditional way of matching buyers and sellers is for dealers to take on the risk. The details of a transaction are often only known by the counterparties involved, so information on the price and volume agreed is not disseminated to the wider investing public. That explains why personal relationships matter in bond markets. Due to the market’s segmentation, quotes and trade prices for the same bond at the same time could vary greatly across dealers.
However, the market began changing when MarketAxess introduced a new trading model in 2012 that facilitated trading between multiple parties (including business between different buy-side parties).
The introduction of an “all-to-all” model at one of the world’s largest corporate bond trading venues structurally changed the market’s dynamics. It also allowed participants to trade across different time zones, offering new sources of liquidity (for example, by enabling European investors to buy Asian dollar corporate bonds from Asian investors).
“The all-to-all-thing trading platform is going to blur the roles of buy and sell-side firms,” said Philipp Sterner, head of Asia sales at MarketAxess. “Buy-side execution trader will be mostly impacted by the rise of electronic trading, unless it requires a human touch to handle complex structured products or a big block of securities,”
Sterner said the company was inspired by technology startups such as Uber and Spotify, which have fundamentally changed the way people get a taxi or listen to music.
“Like Uber and Spotify, we [found] a new way to do business in our market,” Sterner said.
The volume of emerging market bonds traded through MarketAxess, including Asia’s dollar-denominated and local-currency debt, rose by 21.8% year-on-year to $71.5 billion in the three months to September. In addition to G3 Asian debt, the US-listed company trades bonds denominated in Singapore dollar, Malaysian ringgit, and Chinese renminbi.
Mifid II
Another factor likely to drive change in bond trading is the looming adoption of the European Union’s revised The Markets in Financial Instruments Directive, or Mifid II, which promotes investor protection by increasing transparency in data and relationship disclosures.
“I think Mifid 2 will increase the speed of adoption of electronic trading in Asia as it will provide transparency for clients,” Bouwman said.
Mifid II, a package of regulations, is set to take effect across the EU from January 3, 2018. The changes will add administrative costs to the industry, which range from having to charge investors for research and boosting transparency in bond trading to new limits on commodity derivatives trading.
Keith Pogson, a senior partner for Asia-Pacific financial services at consultancy EY, believes EU regulators will need to be flexible when they look at how financial institutions in Asia implement the new rules when doing business with European counterparties, given their complexity.
“If you look across Asia, electronic trading flourishes in the Japanese government bond because it is a liquid and transparent market,” Pogson said. “So I think the most important factor for technology adoption is liquidity, as clearly seen when you contrast G7 and local-currency bond markets.”
In that respect, China is fertile ground for the successful development of electronic bond trading. The Chinese government appears keen too. In July, Beijing offered a streamlined channel for foreign investors to access its $9.4 trillion interbank bond market – the world’s third largest after the US and Japanese markets – without the need for an onshore account.
Given the sheer size of the Chinese domestic debt market and the higher yields on offer, the attractions for overseas investors are clear. Now, about $9 trillion of global developed-market sovereign debt yields less than zero. In contrast, the yield on the benchmark five-year Chinese government bond is 3.852%.
The market’s growth prospects also look alluring. In a June report, UBS Asset Management predicted that the size of the Chinese bond market will double in the next five years, surpassing Japan’s as the world’s second-largest bond market. In addition, it forecast that the Chinese local government bond market will expand threefold to $3 trillion in the next three years.
So it’s no surprise Neuberger Berman Group, a New York-based fund management firm, has described China as a “hot spot” for competition between global funds. It is eyeing a new private fund focused on Chinese bonds after Fidelity became the first global firm to do launch one in China in early May.
“China offers the best hope (after Japan) in the region to adopt electronic trading given its sheer volume of government and corporate paper,” Pogson said. “The Chinese market has increasingly both the depth and breadth of market, as well as improving access for foreign investors.”
MarketAxess says the trading volume of local currency bonds in Asia, including Chinese bonds, has steadily increased since the second quarter of 2016. A total of $1.7 billion of these bonds changed hands through its platform in the three months to September, up from $1.11 billion the previous three quarters.
It’s early days still, but something is happening.