While leadership on bond trading desks hasn’t materially changed over the last decade  – bulge bracket banks and their large balance sheets still dominate – there are new dynamics propelling smaller regional firms to compete. Kevin McPartland, head of research and market structure at Greenwich Associates, recognizes this dynamic while noting a more current demographic shift among employee skills desired. In an industry where relationships still reign, a new generation of technically sophisticated talent is being sought to meet the challenges of electronic trading.

Bond Trading Desks
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Bond Trading Desks  – Bulge bracket relies on balance sheet, technology, regional competitors attempt to differentiate with ideas

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The top five dealers among secondary investment-grade corporate bonds and high yield corporates have dominated nearly two-thirds of the bond market for the last ten years. Looking at a wider angle bulge bracket banks account for 93% of investment grade credit cash bonds and 83% of high-yield credit cash bonds.

What drives the trading desk decisions? According to 75% of fixed-income traders and sales professionals surveyed who work in 46 US and European banks and regional brokers, the relationship is king.

While all categories of broker agreed in unison on the relationship mattered most in bond counterparty decisions, nuanced differentials were apparent based on factors unique to each major broker type.

For instance, “the bulge bracket still considers their balance sheet as one of their top differentiators, alongside their ability to provide quality executions,” McPartland noted. If brokerage balance sheet is the key criteria for decision making, it can become a systematic decision-making process to whitle down the potential counterparty type. To compete, the smaller firms use their brains, not brawn.

“Unlike the bulge bracket, the middle-market adds and retains clients primarily with ideas,” focusing on niche markets the larger banks don’t cover. Half the middle-market respondents in the Greenwich study pointed to quality content as a top differentiator, “trailing only the ever-popular relationships.”

Most of the smaller bond shops have relationships with large investors. The Greenwich study shows 96% of U.S.-based high-grade corporate bond investors trade with middle-market dealers. While the relationship contact percentage is high, they only trade nearly 15% of their total volume with middle-market players.

Bond Trading Desks - With regulatory concerns comes a different benchmark for success

The market landscape has shifted recently, in large part, to changing regulations and capital requirements. What at one point was bond trading desks where success was correlated to revenue and market share, now profitability and return on equity, key decisions when capital restrictions are at play, become more relevant to measure performance.

When institutional investors make counterparty decisions, the bulge bracket touts scale, balance sheet size, liquidity during crisis and technology, with regulatory concerns playing a role. There was a day when bulge bracket desks would purchase bonds and hold them, but that has changed as regulations discourage such behavior. The regulatory issues are not just touching one segment of the market, but hitting all.

“Whereas the bulge-bracket banks are more concerned with rising costs and limited balance sheet, regulatory concerns are particularly acute for the middle-market dealers, with over three quarters citing regulatory compliance and over two-thirds regulatory uncertainty as top concerns,” the report observed, pointing to the large market participants advantage to hire a deep compliance bench. Illustrating the divide, 75% of regional players said compliance was the key to success in the coming year, while only 46% of bulge bracket banks thought as much. Regulatory uncertainty was a top concern regardless of dealer size.

In the era technical disruption and Amazon, where the ability to manage a relationship has been and still is considered the top skillset for a bond trading desks dealer, that focus is changing, if ever so slightly. Sector specific bond knowledge along with the ability to be fluent in the language of electronic trading matter. Nearly 60% of sell-side firms are looking for employees with an understanding of market structure, trading venues and new data sources.

“Electronic trading, with all of the disruption it has brought with it, has created new opportunities for dealers big and small,” McPartland wrote. “It continues to level the playing field, providing access to clients that otherwise might never have materialized when a portfolio manager’s direct line was needed to establish a trading relationship.”

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