Corporate bond market participants weigh liquidity alternatives

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Improved pre-trade data will be one of the keys to helping buy side firms increase their comfort level with adopting new trading models, participants of a Tabb Group forum said last week.

With dealer inventories of corporate bonds at historic lows, there has been much debate about where buy side firms will find alternative sources of liquidity to make up for the lost inventory that is no longer available from dealers. One stumbling block is that some buy-side firms have expressed concerns about how they will be able to document best execution for compliance purposes with alternative trading models.

"We hear from buy-side clients, 'we were thinking about trading bonds but we weren't sure about the reference points of what was the fair price for that bond,'" said Mark Hepsworth, Interactive Data's president of pricing and reference data. "The more information we can put in a pre-trade environment about what is the value of that bond, the more confidence we will see."

Historically, when buy-side firms executed trades by calling several dealers and selecting the best price, best execution was easy to document. The issue is that in electronic venues where buy side firms might be in the position of posting a price, rather than selecting the best one, there is uncertainty of how they will demonstrate that the price they posted was the best available execution. The counterargument is that increased data of where corporate bonds are trading will help buy-side firms justify the price they are posting.

"A lot of the solutions we are looking at--buy side-to-buy side and cross trading--will require a price discovery mechanism that doesn't have to represent an actionable trade, but that is reliable for the SEC or for other purposes to document the price at which you do a cross or a buy side-to-buy side trade," said James Wallin, senior vice president of fixed income with AllianceBernstein.

"When you have a market moving from what has been a dealer-principal trading model to something that has to be very different, in our opinion the solution will require change from all market participants," added Richard McVey, chairman and CEO of MarketAxess. "Issuers have a role to play in moving toward more standardized securities so we don't have so many CUSIPs in the market; electronic platforms such as MarketAxess have a role to play in increasing market connectivity to develop new sources of liquidity; and the buy side has a role to play because it requires a significant change in behavior to go from requesting bids and offers to a market that needs to work all-to-all where investors are sometimes going to be the ones to lead with a price."

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