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At the beginning, Europe created the union and the currency. But the bond market was shapeless and empty; and darkness was on the face of the deep. The Commission therefore said: “Let there be light: and there was light.” And Europe saw the light, and it was good; and Europe separated odd lots from block trades.
Apologies for Genesis 1:1-4, but it was the first thing that came to mind when FT Alphaville read an interesting report from Barclays credit strategists on the introduction of a consolidated strip for the European financial market.
This is a very big deal across the board, but particularly for the corporate bond market, which in Europe is balkanized and opaque even by fixed income standards, with only around 8% of transactions reported in near real time.
This will now change dramatically, and the impact will ripple through European bond markets and change the way fixed income is traded, according to analysts at Barclays. Here are their main points, with FTAV’s emphasis below:
— Faster publications and the arrival of a consolidated band will significantly increase transparency in the European corporate bond market, from the current 8% of transactions reported in real time to over 80%. The tape will provide a single reference source for prices and volumes, making trading data accessible to a wider range of market participants.
— We find that, under current market conditions, the effects of transparency on corporate bond liquidity are more varied than previously thought. Transparency reduces transaction costs for small transactions and newly issued bonds, but it increases transaction costs for large transactions and older instruments. These nuances relate to two important changes in the corporate bond market over the past 20 years: post-crisis regulations that increased capital requirements for banks and increased the cost of inventories, and the introduction of ETFs.
— When inventory costs are high, publishing transaction details may place market makers in a more vulnerable position once they hold a bond in their inventory and seek the other side of the transaction; ETFs provide real-time information on the price of corporate credit risk, potentially reducing the benefits of transparency. When it is difficult to quickly match buyers and sellers – as is the case with block trades – higher inventory costs can offset the benefits of transparency and lead to decreased liquidity.
— Transparency, combined with increasing “electronics”, will likely reshape volume distribution in the future: it will be easier and cheaper to execute small transactions on electronic platforms, and more difficult to trade blocks, which will rely more and more on expertise. and voice trading networks. The band has the potential to accelerate systematic investment, generate more trading activity through improved confidence in price markets and attract new investors.
— The mixed effects of transparency we uncover will have important implications for the distribution of liquidity, as well as the types of strategies investors use to adapt to the changing liquidity ecosystem. Our results suggest that policymakers will need to strike a delicate balance between exploiting the benefits of transparency and preserving liquidity for large transactions.
It took a long time, even though a consolidated band is an essential, if controversial, part of the truly unified and dynamic European capital market, championed by the likes of Christine Lagarde.
The United States has had the Trade Reporting and Compliance Engine – or TRACE – for corporate bonds since 2002. Mortgage-backed securities and municipal debt were later included, and more recently the US Treasury market was also integrated.
The big banks have never appreciated the transparency that TRACE has brought to the US bond market, emphasizing without injustice that it is more difficult for them to buy large shares of fixed income securities from their clients when the transaction is announced at all of Wall Street in 15 minutes.
These whispered complaints became a cacophony after the financial crisis, when heavier regulations killed proprietary trading desks and reduced banks’ ability to make markets, and fears of “bond market liquidity” were rampant. .
But Barclays’ main argument is that the nature of liquidity becomes differentrather than better or worse in itself.
Smaller tranches of bonds become easier and cheaper to trade, while larger blocks are slower and more expensive to unload. Specifically, Barclays estimates that the European Band will reduce transaction costs for small transactions by 5 to 7 percent and increase transaction costs for large transactions by 10 to 15 percent.
However, Alphaville suspects the net effect will still be positive in Europe, given that trade sizes are on average smaller – and continuing to decline – as electronification advances. As Barclays notes:
For example, in the past year alone, the average trade size in Europe has decreased by around 30%, from €750,000 to €550,000, fueled by the growing share of e-commerce, which has gone from 36 % of total volumes at 46%. during the same period. Although “electronic” is invariably a global trend, the share of e-commerce in Europe is significantly higher than in other credit markets, such as the United States. The introduction of transparency in Europe will likely accelerate and amplify these trends. Electronic trading focuses on “easy” trades, or smaller tickets and liquid bonds, which are precisely the type of trades and instruments that will benefit from transparency, according to our analysis.
Furthermore, the European bond market – even the credit market – will likely look more and more like the equity market over the next decade.
