4 Corporate Bond Electronic Trading Trends to Watch in 2013

1. Trade sizes will continue to gradually decline.

Voice based trading naturally consumes more time than electronic trading so it makes sense that as block- sized liquidity declines, market participants will seek greater efficiency via electronic execution. The sweet spot for electronic trading in corporate bonds currently appears to be for sizes under $1 million. Interestingly, since 2009, the average daily trading notional volume has grown 33% for trade sizes between $100 thousand to $1 million. In contrast, daily notional volume between $1 million and $25 million has only increased by 6% over the same time period .

2. Market making will continue its recent shift from larger dealers to smaller, more regional dealers.

Large banks and broker dealers will continue to be very relevant in market making but we expect the flow to be less concentrated to the largest firms. Regulatory reform is restraining bank balance sheets, presenting opportunities for middle market and regional dealers to step in as replacements. According to TRACE, the top 10 most active dealers have seen their market share decrease 6.9% from 2009-2011 while everyone else has increased their market share by the same amount.

[2013 Electronic Trading Outlook: More Pressure on Tap for the Sell Side]

3. Trading efficiency becomes paramount in this ever lower yielding environment.

With the current yield of Barclays US Credit Aggregate Index at 2.60%, investors are having an increasingly difficult time generating Alpha. Given the average bid/offer spread of 14 bps for investment grade corporate bonds, the transaction cost composes of 5% of the total security yield. When Alpha is scarce and transaction costs are high, conscious managers will look to boost returns by simply increasing trading efficiency and cutting trading costs. Automation and electronic trading remains the best tactic to accomplish this in today's environment.

4. Data transparency will continue to increase and market participants will figure out innovative ways to leverage this tool.

A few years ago bond pricing information was mostly useful for mutual funds to market their portfolios to market. This usually happened every month-end. In 2002 with the initial implementation of TRACE, corporate bond prices became available 15 minutes post trade. This changed the way market participants utilized and viewed market data. Over the years, just about every fixed income asset class has become reportable on TRACE (Corporate, Agency, Securitized Products). Combine this with advancing technologies in streaming real-time bids and offer pricing pre-trade, the amount of actionable information available to participants has drastically increased. In this new paradigm, innovative technology firms and savvy traders will figure out ways to utilize this wealth of data to their advantage within the marketplace.

Market practitioners have long debated whether corporate bonds will have a future in electronic trading. I am certain this debate will continue, in 2013 and beyond. However, let's not forget the old trader adage "the trend is your friend". Given some of the trends outlined in this article, the concept of corporate bond electronic trading feels like a friend you may want to stay over for awhile.