When Rick McVey worked for JPMorgan Chase & Co. in the 1980s and 1990s, he watched as futures traders, who once donned colorful jackets in the Chicago trading pits and screamed out to execute an order, moved off the floor as their business migrated to electronic markets.
With that experience in mind, McVey in 1999 outlined a plan to apply the same idea to the voice-based business of trading corporate bonds. The idea marked the genesis of MarketAxess Holdings Inc., an electronic trading company specializing in fixed-income trading that McVey still leads as chairman and CEO.
"Our vision was that we would improve transparency and efficiency and competition in the fixed-income marketplace by developing a central electronic market for institutional investors and dealers," he said in an interview.
Others saw the same opportunity. At the turn of the century, dozens of electronic-trading companies flocked to the space in a rush to develop a platform best suited for the ever-growing but illiquid corporate bond market.
But in the ensuing years, electronic corporate credit trading struggled to gain traction the way those companies had hoped. Traders still reached for their phones and typed emails and chat messages to trade the hundreds of thousands of outstanding corporate bonds.
Now, that dynamic is finally beginning to change, with a handful of companies — MarketAxess, TradeWeb LLC and Bloomberg LP — leading the shift. MarketAxess dominates the corporate bond electronic trading market with an 85% share, versus TradeWeb and Bloomberg's respective 6% market shares, according to data from research and consulting company Greenwich Associates.
In 2017, nearly 85% of investment-grade investors used an electronic trading platform, and electronic trading accounted for about 20% of all corporate bond trading volumes, nearly double the 11% share in 2007, according to Greenwich Associates.
While the vast majority of corporate bond traders still rely on phone calls, emails and chat messages to execute their clients' orders, many industry experts believe electronic-trading companies are primed to continue to siphon volume away from traditional methods.
Trading over the phone has some advantages: doing so allows a trader to try to pinpoint liquidity for a bond while keeping options close to their chest, a necessity as illiquid bonds are particularly susceptible to price swings when investor interest is piqued, TABB Group Founder and Research Chairman Larry Tabb said in an interview.
But investors by and large have still been left to wonder where they can offload companies' bonds when necessary, as a host of factors ranging from the market's growth to regulatory reforms have only made liquidity more scarce.
In equity markets, stock trading is centralized on just a few dozen stock exchanges and private alternative trading systems known as dark pools. That system, and the comparatively small number of equities that trade, makes for an extremely liquid market.
But corporate bond traders face the far more difficult task of sniffing out a bond's price through interpersonal relationships and knowing exactly who would be willing to trade one of the hundreds of thousands of corporate bonds at a given time.
"Liquidity's not a god-given right," Richie Prager, head of trading, liquidity and investments platform for BlackRock Inc., said Jan. 11 during a fixed income-focused meeting at the U.S. Securities and Exchange Commission.
Dealers, including big banks, used to snatch up bonds in the primary markets with the intention of holding and eventually selling the bonds to retail investors. But regulatory reforms in the wake of the financial crisis, including the Volcker Rule, limited banks' capacities to hold risky assets on their balance sheets. Banks, as a result, have been regularly forced to offload bonds soon after acquiring them.
"Finding a buyer and a seller of a similar size at an agreeable price at any moment in time is no small feat," Kevin McPartland, Greenwich Associates' head of market structure and technology, said in an interview. "That makes it hard to fully electronify the market."
The changing landscape has drawn new regulatory interest with the launch of the SEC's Fixed-Income Market Structure Advisory Committee, a group of industry executives, academics and experts, including McVey and Tabb, which regularly meets with agency officials.
"These markets are now in a period of profound and multi-faceted change," SEC Commissioner Kara Stein said Jan. 11 during the committee's first meeting.
Two of the world's largest asset managers, BlackRock and AllianceBernstein Holding LP, plan to process all their corporate bond trading through an electronic-trading platform in 2018. But the companies' plans will not completely leave their traders' phone calls and chat messages behind entirely, executives from both companies said at the January meeting.
The rise of electronic trading in the corporate bond market also provides some relief to companies from Europe's sweeping financial reform known as the Markets in Financial Instruments Directive II, or MiFID II. The regulation requires that all trades be reported to regulators, but traders using an electronic platform could escape that headache as the burden of reporting trades would fall to the platform, PricewaterhouseCoopers partner Chris Scarpati said in an interview.
Platform providers are also bolstering their data offerings as investors look to operate with better price discovery in the bond market, where the number of bonds and infrequency of trades make it difficult to accurately determine a bond's price.
Now, with more than $900 billion in U.S. corporate bond issuances in 2017, the corporate bond market is booming, and investors want more price clarity.
"In yesterday's world, you go in to buy a car and that Cadillac costs $24,000. You may negotiate a few thousand dollars off the price," Scarpati said. "In today's world, you already go in knowing what the dealer paid for the car. You know where your wiggle room is with that dealer. It's the same thing in this space."
Ultimately, electronic trading platforms hope bond trading will more resemble the stock exchange model.
Certain companies have started to introduce "all-to-all trading," or open trading, as a means of expanding the available supply. The model upends the prior status quo in bonds, in which a dealer makes trades after receiving an order from a client. Open trading allows clients and dealers to exchange with each other in a more fluid manner.
"Trading in corporate bonds is quickly moving to a more efficient and liquid model," MarketAxess' McVey said.