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Making the Connection: The Electronic Shift in Legacy Credit Market Workflow | July 2018

Making the Connection:

The Electronic Shift in Legacy
Bond Market Workflow
V16-024 | July 2018 |

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Making the Connection: The Electronic Shift in Legacy Credit Market Workflow | July 2018

Table of Contents
Introduction ................................................................................................................... 3
The Principal-Risk Trading Footprint .......................................................................... 4
Efficiency Mechanisms Plugged In.............................................................................. 5
What’s the Protocol Here? ........................................................................................... 6
Finding the Right ‘Spot’................................................................................................ 8
Casting a Wide NET .................................................................................................... 9
Bringing out the Data ................................................................................................... 9
Conclusion ................................................................................................................... 11
About ............................................................................................................................ 12
TABB Group .............................................................................................................. 12
TABB Group Fixed Income Practice .......................................................................... 12
The Author ................................................................................................................. 12

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Making the Connection: The Electronic Shift in Legacy Credit Market Workflow | July 2018

Efficiency is doing things right; Effectiveness is doing the right things
Peter Drucker

Thanks largely to the growth of electronic trading in the US corporate bond market, liquidity isn’t the
elusive target it was three years ago. For trades below the round-lot threshold of $1mn, it is easier
today than ever before to trade US credit, evidenced by the fact that since 2009 average daily notional
volume traded in corporate debt has grown from just under $20 bn to roughly $30 bn today and
turnover ratios for both high yield (HY) and investment grade (IG) debt has been steady for the past
several years (Exhibit 1).

Exhibit 1: US Corporate Bond 12 Month Rolling Turnover Ratios

Source: TABB Group, MarketAxess

This progress has created challenges, though, as firms managing both electronic and voice-based
execution must reconcile these two distinct workflows. The fact is, even as pure electronic trading
rapidly gains momentum in the corporate debt markets, relationship-oriented trading still represents
an estimated 70%-80% of the notional volume traded within the US credit markets. This foundation
is unlikely to be upended in the near term. TABB Group projects that over the coming decade this
percentage might drop 5-10%. Buy-side firms will be faced with the task of transitioning legacy
processes into new models that need to acknowledge elements of the relationship-based voice
trading past within an electronic trading workflow.

In this report we highlight some of the new electronic tools that have made significant inroads with
US credit trading in recent years and firms that are striking the right balance between old and new to
achieve improved trading efficiency and effectiveness.

© 2018 TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission.
Making the Connection: The Electronic Shift in Legacy Credit Market Workflow | July 2018

The Principal-Risk Trading Footprint

The US credit market has continued on a trajectory of growth for the majority of the decade, as rates
have remained low and central banks have been large buyers of financial assets. Notional size
outstanding in corporate debt has increased by $3.55 tr or 68% since 2007 (Exhibit 2). Last year $1.6
T in new issuance entered the market compared to $1.05tr in 2010 (Exhibit 3). The confluence of an
increasingly large and concentrated market has set the stage for innovation in the space.

Exhibit 2: US Corporate Bond Notional Value Outstanding, $ Billions


2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Source: TABB Group, SIFMA

Exhibit 3: US Corporate Bond Annual Issuance, $ Billions

Source: TABB Group, SIFMA

Unlike other markets that have more widely adopted fintech innovations, the US corporate bond
market is still an intensely personal, relationship-driven market. Accordingly, a central tenant of the
electronic evolution occurring within the US corporate bond market is that dealer-oriented execution
will likely remain a cornerstone of credit trading. A recent TABB Group research report, Principal-
risk trading in US Corporate Bonds: The Undeniable Liquidity Dilemma, dives into this point in
great detail. Our research demonstrates that underlying the vast liquidity complex that is the US credit
market, buy-side dependency on dealer principal-risk trading is pervasive. Underscoring this point is
the fact that the Federal Reserve recently proposed revisions to the Volcker Rule that would allow
banks to more effectively and confidently utilize their balance sheets.

© 2018 TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission.
Making the Connection: The Electronic Shift in Legacy Credit Market Workflow | July 2018

Immediacy or the need for “on-demand” liquidity on the part of market participants, has pushed
investors deeper and deeper into the corporate credit markets. In a recent TABB Group survey of US
credit market participants that included 25 dealers, 30 large asset managers, and roughly 20 other
market participants there were several standout themes shared among the group. First, despite a
vast set of metrics reflecting healthy liquidity (consistent year-over-year growth in notional volume
outstanding, annual issuance, and average daily volume traded), the overall sentiment is that liquidity
has and continues to be sub-optimal.

Efficiency Mechanisms Plugged In

Electronic credit trading platforms have pitched themselves as the solution, capable of leveraging
technology to create new layers of connectivity and unlock liquidity. In some cases, they have been
successful. Given these factors, TABB Group estimates that electronic IG corporate bond trading will
reach 24% in 2018 (Exhibit 4). If we expand this measure across both investment grade and high
yield, electronic trading currently accounts for between 20-23% corporate bond trading volumes.
Volumes also suggest that the buy-side is slowly becoming accustomed to trading larger size
electronically, with new entrants as well as incumbent platforms all reporting significantly higher block
volume being executed on their platforms compared to a few years back.

Note: The slight dip reflected in electronic trading market capture in 2017 seen in exhibit 4 is not
reflective of a decrease in usage of new electronic credit trading platforms. Instead, the drop in
percentage value is a result of the overall (electronic and voice trading) market’s growth in size
against a temporarily plateaued rate in adoption in electronic platforms following the boom of on-
boarding that occurred the year before as these solutions were rolled out.

Exhibit 4: US & IG Electronic Credit Trading as % of Total Volume

Source: TABB Group

© 2018 TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission.
Making the Connection: The Electronic Shift in Legacy Credit Market Workflow | July 2018

Despite this significant uptake, though, roughly 75-80% of credit volume is still executed as voice
trades, even if later electronically processed. Addressing those voice trading hold-outs has become
a focal point for electronic trading venues looking to move the market toward fully electronic
execution. Increasingly, they are finding that the key to achieving that goal is creating obvious
efficiency gains while also preserving the relationship-driven roots and related workflows that have
been the cornerstone of the credit markets. Tools are being developed that intersect the established
voice-based trading segment of the market (which the majority of buy-side firms still prefer for the
largest and most difficult trades) with efficient electronic processing mechanisms layered on top. By
focusing on efficiency mechanisms and data solutions rather than upending the traditional dealer
voice business, electronic trading venues have begun to save institutions significant time and cash,
without radically up-ending the legacy trading process.

As an example of this, consider the growth of Tradeweb’s US credit platform over the past year.
Notional volume in investment grade and high yield US corporate bonds topped $102bn in the first
quarter of 2018, more than double that of Q1 2017. Roughly 75-80% of that volume was made up of
electronically-processed voice trades. The rest was fully electronic. What that statistic shows is that,
even for a firm that pioneered fully electronic trading, the key to unlocking electronic trading in the
corporate credit market is finding the right balance between streamlined electronic processing and
decidedly offline, one-to-one trade execution.

While all platforms do not provide public data on their electronic processing volumes, Interviews with
market participants suggest that Bloomberg, MarketAxess, and Tradeweb’s processing services for
voice executed trades are essential. Although publicly available data is limited, the figures from
Tradeweb certainly underscore this trend – in Q1 2018 the volume of IG corporate bonds that was
electronically processed there accounted for roughly 4.8% of the total US investment grade TRACE

What’s the Protocol Here?

The proliferation of new electronic trading venues for US corporate bond trading over the past three
years has afforded market participants innovative and flexible execution options that would have
been science fiction less than a decade ago. These new protocols fall along a wide spectrum of
liquidity. Where the traditional RFQ model was once the best and only option for buy-side credit
traders, today’s landscape of electronic execution venues offer an expanding list of innovations-
although the percentage of volume traded electronically is still significantly RFQ-led, the bulk of which
is still executed through incumbent electronic platform MarketAxess.

© 2018 TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission.
Making the Connection: The Electronic Shift in Legacy Credit Market Workflow | July 2018

Exhibit 5: MarketAxess Open Trading Statistics

Open Trading Volume as % of Total Product Traded Open Trading Quarterly Volume

Source: TABB Group, MarketAxess

The average trade size on MarketAxess has also grown consistently over the years from what was
initially an odd-lot focused solution. The MarketAxess all-to-all open trading functionality has similarly
seen healthy growth in recently. Today, Open Trading volume as a percent of total product volume
on the platform accounts for roughly 17% of investment grade, 38% of high yield, 13% of Eurobonds,
and 11% of emerging markets trading as of Q1 2018 (Exhibit 5).

Following the surge in electronic credit trading over last few years, the landscape of platforms
operating today that capture significant portions of the market have thinned significantly. In TABB
Group’s 2015 report, Platform Propagation: A Comparative Guide to E-trading US Corporate Bonds,
seven platforms were profiled: Bloomberg, Electronifie (no longer open), Liquidnet, MarketAxess,
MTS Bonds Pro, Tradeweb, and TruMid. Each was categorized according to the approach taken to
solving the liquidity challenges facing the market at the time. Since then, there have been several
shake ups with respect to the platforms active today although the principal theme of consolidation
and competition among only a small subset of solutions remain true today.

How participants have utilized the array of trading protocols available to them varies by bond type,
size, and sector. Voice RFQ remains the dominant protocol for trading both high yield and investment
grade credit. As more investors become comfortable trading credit electronically, the opportunity to
evolve past RFQ has emerged as a growth area. For instance, institutions looking to reduce time
spent working small odd-lot orders are more likely to use a shotgun style all-to-all RFQ to all
participants in the network through channels like MarketAxess’s Open Trading, Tradeweb’s Blast
A2A functionality, or Liquidnet or TruMid’s all-to-all functionality. Firms with existing non-institutional
or mixed retail and institutional liquidity pools, such as Tradeweb Direct and MTS Bond Pro, are fully
embracing an all-to-all environment. This opens up buy-side institutions to a new set of liquidity in
the odd-lot credit space.

Firms offering entirely new credit trading protocols have experienced positive growth in recent years
too. TruMid, which acquired Electronifie in early 2017, for example, announced earlier this year that

© 2018 TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission.
Making the Connection: The Electronic Shift in Legacy Credit Market Workflow | July 2018

it had captured monthly volumes of $2 billion, more than double their year over year activity. Although
this is still a small fraction in terms of the percentage of overall TRACE volume reported, these are
strong overall figures considering their recent launch in 2015. TruMid utilizes watch lists and
indication of interest (IOI) protocols to match up buyers and sellers across over 22,000 bonds in
session-based trading environments.

The increasing protocol flexibility buy-side participants have at their disposal allows investors to
digest their workflow, customize strategy, and potentially reduce the all-in cost of their trading. The
new landscape will continue to benefit from solutions that aim to address not only the overall liquidity
accessible on the platform but the overall cost and efficiency of the trading process.

Finding the Right ‘Spot’

While market structure is indeed proving to be one important part of the adoption curve for electronic
trading in the US credit market that does not mean other parts of the trading workflow aren’t being
radically altered. One increasingly adopted workflow solution within US credit trading is the auto
spotting processing for investment grade (IG) credit spread trades.

Treasury spotting has remained a manual and relatively tedious process for decades. Traditionally
conducted over the phone, it requires the credit salesperson to get an up-to-date spot level from the
Treasury desk, and relay that information back to the client who would then agree to and execute the
trade. Some of the challenges faced by market participants transacting this way include uncertainty
around the quality of pricing, the time necessary to execute the hedge by phone, and the possibility
for late or incorrect trade reporting.

For example, Tradeweb has integrated all of those manual steps into an automated workflow. Once
a client completes an electronic credit trade, they can trade directly with the winning liquidity
provider’s Treasury desk. In a nutshell, the introduction of an automated back-end infrastructure
between the credit and Treasury desks removes layers of negotiations that slowed trading between
these two complementary asset classes in the past.

The buy-side participant now has the ability to designate when to spot their trade, as long as the
treasury hedge is accepted within the linked treasury platform’s execution network, the interest rate
and credit risk of waiting for a dealer to get a final price back on the investment grade bond is
mitigated. The sell-side similarly benefits from this mechanism. Slippage in the traditional process
would arise from the difference in the treasury reference price for a spread trade originating at one
time and the actual spot price at the actual execution of the trade. Linking these mechanisms together
through electronic automation minimizes this slippage.

© 2018 TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission.
Making the Connection: The Electronic Shift in Legacy Credit Market Workflow | July 2018

Casting a Wide NET

Multi-trade netting protocols, like that developed by Tradeweb, are another component of the
electronic trading workflow that take the spotting automation process for single trades a step further
and addresses the intrinsic transaction costs associated with executing large volumes of tickets.

Asset managers active in corporate credit typically trade in and out of multiple bonds on a daily basis,
at times entire portfolios. For institutions working with a single dealer that might have bought and
sold different bonds with matching maturity benchmarks, there is opportunity to achieve some netting
efficiency across treasury hedge positions; the benefit increases further when looking across multiple

Institutions electronically processing large batched of corporate bond trades throughout the day can
easily net the aggregate risk across the dealers and hedge the aggregate net risk with a single
treasury hedge trade per benchmark through Tradeweb’s linked treasury platform. This optionality
has already begun to create significant savings for an increasingly cost-conscious buy-side in terms
of treasury hedge execution fees. With trillions of dollars of estimated Treasury trading as hedges for
corporate bond trading a year, the industry-wide risk reduction and cost savings of multi-dealer net
spotting could be close to $1 billion, if not more.

Bringing out the Data

Innovations with new, flexible execution protocols and efficiency mechanisms have also opened up
new types of data-based opportunities. Data-driven execution is an increasingly prominent theme
among institutions utilizing electronic credit trading technology. While the early days of credit trading
electronic offerings were homogenous both in terms of market data and execution protocols, a
threshold of adoption has been reached today such that platforms have begun to double down on
differentiating what they can bring to a buy-side client outside of the traditional pitch of large liquidity

Different approaches to applying analytics to public and internal data streams, pre-trade liquidity
metrics and scoring, counterparty strategy, and granular best execution solutions are among the top
avenues of differentiation among electronic platforms today. The reality is that two hypothetical
institutions that are similar in strategies and PM/trading desk sophistication can achieve very different
outcomes depending on their use of electronic liquidity, aggregated data solutions, and execution
tools and protocols.

Platforms have begun to launch intelligent workflow assessment tools that leverage the unique and
growing pool of credit market data available to clients utilizing electronic platforms today. While
traditional workflow and relationship-based trading still command the vast majority of institutional
volume on a day to day basis, data-driven execution strategies have tremendous room to grow. The
core concept is taking a closer look at a given institutions’ orders (the granularity of the assessment
becoming increasingly deeper for electronic platform activity) and using this metadata to make

© 2018 TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission.
Making the Connection: The Electronic Shift in Legacy Credit Market Workflow | July 2018

decisions for future orders in terms of where to send them, which counterparties to engage, and
which protocol to use. The combination of bespoke preferences in terms of an institutions agenda
and customizable analytics opens new doors for trading and automating processes.

For example, Tradeweb has recently begun to leverage existing solutions from other asset classes
such as Treasuries and European bonds and apply these solutions to all electronic markets. Its
Automated Intelligent Execution tool (AiEX) works by linking a client’s Order Management System
(OMS) directly to the platform and fully automating the execution if a set of predetermined conditions
(e.g., price tolerance, minimum number of responses) are met.

Other platforms have similarly brought to market data-based solutions that leverage proprietary
technology and market insight. Bond pricing has for a long time been a significant issue for market
participants. Investors are increasingly relying on pre-trade and real-time price modeling. Because
corporate bond trading is concentrated in a very small subset of highly-liquid issues, the vast majority
of issues (unique CUSIPs) do not even trade on a daily basis, creating a major challenge to best
execution and pricing analytics. Recently TruMid has added a proprietary continuous bond pricing
engine (FVMP) that leverages public and platform-specific data for IG, HY, and distressed bonds.

Last November Liquidnet launched Virtual High Touch (VHT), their smart-workflow assessment tool
that aims to capitalize on the technological advantages buy-side firms are eager to embrace today.
In addition to providing customizable analytics that focus on everything from order size, issue size,
recent activity or bespoke preferences, VHT allows for custom ‘execution stations’ that can send
orders to their dark pool, lit order book, or specific counterparties. The workflow can be further
customized in terms of where and how orders are dealt with throughout the day. The high degree of
step-by-step touch points or customizability factors that these platforms afford investors serves a
secondary benefit of providing a robust audit trail such that a trader can easily justify their decision
and outcomes to regulators and investor and compliance committees.

© 2018 TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission.
Making the Connection: The Electronic Shift in Legacy Credit Market Workflow | July 2018

The realization is starting to take hold that the market is pulling away from the liquidity conundrum
that has plagued it over the last half decade. For the largest size trades, liquidity still comes at a
premium and relationship-based, voice-trading is still far and away the preferred mechanism for
getting size done. This traditional component, however, is undergoing a transformation in its own
right as electronic processing becomes more widespread and in turn improves trading efficiency.

The principally intermediated market is, for better or worse, the glue that holds the credit market
together. New tools and solutions that embrace this element of the current market structure and
enhance the underlying processes are in the best position to succeed. Today, the adoption of new
efficiency mechanisms that aim to bring the benefits of electronic processing to traditional,
relationship-oriented trading (which still makes up the majority of risk transfer within US credit
markets) is outpacing other avenues of electronification.

While still the dominant mechanism, RFQ is no longer the only execution protocol in the day-to-day
tool chest of institutional credit traders. In today’s credit trading environment, there are clear
opportunity gaps that traditional RFQ workflow can’t address. The leaps and bounds made by firms
offering innovative execution tools and efficiency mechanisms are laying the ground work for the next
evolutionary step the market is looking to take.

While it is still too early to say the extent to which the existing market will shift to the pure all-to-all
venues (or whether the growth there will supplement the existing size of the voice market), it is clear
that institutional credit investors, both on the buy and sell-side, have begun to embrace more of the
electronic landscape in the ongoing search for the appropriate balance of traditional and
technological. The buy-side in particular stands to benefit the most from the electronification of their
overall workflow. Whether for voice and electronically executed trades, the electronic processing
unlocks opportunities to more efficiently link activity in correlated products such as the investment
grade credit and treasury markets. Looking past singular avenues of improvement and innovation it
is safe to say that electronic trading, in whatever form it takes, has and will continue to improve the
entire trade lifecycle for the US credit markets.

© 2018 TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission.
Making the Connection: The Electronic Shift in Legacy Credit Market Workflow | July 2018

TABB Group
TABB Group is a financial markets research and strategic advisory firm focused exclusively on capital
markets. Founded in 2003 and based on the methodology of first-person knowledge, TABB Group
analyzes and quantifies the investing value chain, from the fiduciary and investment manager to the
broker, exchange, and custodian. Our goal is to help senior business leaders gain a clearer
understanding of issues and trends within financial markets, so they can better grow their businesses.
TABB Group members are regularly cited in the press and speak at industry conferences. For more
information about TABB Group, visit

TABB Group Fixed Income Practice

TABB Group’s Fixed Income research examines trading, operational and technology issues
impacting corporate bonds, treasuries, swaps, and other credit and rate derivatives in North America,
Europe and Asia. This includes deep dives on market structure, business models, execution venues,
central clearing, prime brokerage, technology, market data, and compliance. Our research is used
by legislators, regulators and market participants worldwide to make strategic and policy decisions
surrounding fixed income trading and OTC derivatives reform.

The Author
Colby Jenkins, Analyst

Colby Jenkins joined TABB Group in August 2012. Before joining TABB, he was a Global Academic
Fellow at New York University Abu Dhabi in the UAE, serving as a faculty member in their physics
and mathematics departments. He graduated from New York University, earning a BS in physics with
additional focus on mathematics. As an analyst, Colby works within both the TABB consulting service
and the fixed income research group.

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