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Liquidity Shortages driving Transformation in the Fixed Income Market Structure

By 2 Jun, 2016November 11th, 2019Press Releases

Cognito Europe

  • Post-financial crisis regulations are creating temporary shortages in government and corporate bonds liquidity
  • New bonds and swaps trading models are being adopted by banks, allowing them to broker client access to liquidity
  • New generation of enhanced bonds could arise to permanently alter the ways in which corporate bonds are traded

LONDON – 2 June 2016 – A new report from GreySpark Partners, a leading global capital markets consulting firm, forecasts the ways in which the structure of the fixed income market could change in the future to account for the impact of regulation and the creation of new bank methods for bonds and swaps trading.

The report, Trends in Fixed Income Trading 2016, argues that, in the future:

  • The government bonds market will become all-to-all in nature, encompassing both banks and non-bank liquidity providers who will compete as market-makers;
  • IRS liquidity will be transferred into the futures markets to compensate for the costs associated with EU and US central clearing mandates;
  • The corporate bond market could spawn a larger and deeper retail market as a means of allowing buyside firms an independent forum for transparent pricing, enabling more so-called client-to-client interactions; and
  • Single-name CDS liquidity will increasingly be transferred into CDS indices or ETFs, allowing for the creation of greater levels of options products.

These predictions are based on an analysis of the ways in which the depth or amount of liquidity available to banks and buyside firms has grown thinner over the last five years as new regulations increasingly constrain the ability of banks to warehouse counterparty credit risk on their balance sheets.

Specifically, the long-running implementation of the Basel III Accords, the Basel Fundamental Review of the Trading Book proposals, and corresponding EU and US mandates such as MiFID II and the Dodd-Frank Wall Street Reform and Consumer Protection Act – as well as central bank monetary policy decision-making – are driving the occurrence of US Treasuries ‘flash rallies’ or ‘Bunds tantrums’ in the EU and US government bonds markets. The regulations are also responsible for creating a liquidity dilemma in the corporate bonds market in which it is increasingly difficult for many buyside firms to source liquidity or form prices, especially for block-size trades.

In response to these regulatory and macroeconomic pressures, some banks are adopting so-called hybrid agency-principal business models for bonds and swaps trading that allow the banks to more efficiently provision or broker client access to fixed income liquidity. Meanwhile, established corporate credit and government bonds exchanges or trading venues are seeking to diversify the range of different types of liquidity pools and buyside and sellside bonds trading models that they cater to. These efforts by exchange platform operators represent an effort to protect their market share from new, emerging venues or from direct disruption from market participants seeking to trade more directly with one another.

Russell Dinnage, GreySpark lead consultant, said: “The fixed income marketplace in 2016 is increasingly challenged by global regulatory pressures that are decreasing the profit that a bank can derive from government or corporate bonds trading. Some attempts by a range of market participants – including banks, inter-dealer brokers, buyside firms and exchange platforms – to subvert these challenges by creating new trading models designed to increase the velocity at which bonds can be traded off a bank’s balance sheet are showing early signs of success. However, the corporate credit market in particular is attempting to continue to seek profitability from a market structure that is increasingly not fit-for-purpose, and a range of new types of instruments may emerge in the future that are designed to reinvigorate the securitisation industry, which would change the face of the fixed income market forever.”

For further information on GreySpark’s research, please e-mail: