The end game of market making commoditisation is that a smaller number of players provide a vast volume of liquidity to the majority of clients. This direction of travel is predicated upon market structural changes, focusing trading upon a very few trading venues, and direct, bilateral trading between clients and dealers.
Whether this model is preferable for banks in the corporate bond market depends upon several factors. Big banks, looking to maximise their reach and use of balance sheet, would likely be happy to cut down on the number of competitors who soak up / dish out liquidity. For a scale player, competing under this model is right up their street.
There may also be specialists who would see their capacity to service clients as so niche and value-additive that they could not be replicated by larger firms focused on bigger returns.
Mid-sized dealers are more likely to lose out. This model has a few winners and some on the sell-side see it as an inevitable extension of the current path of electronification.
However, FX is not a great model for fixed income. It is focused on the exchange of two currency pairs based on relative value, not the rate of return one gets from holding one or the other.
The capital gains associated with the movement in relative value of a currency, or equity for that matter, are rarely seen in debt markets. A bond pays out – barring a credit event – to the holder, so relative value is only of interest when assessing the mark-to-market value or if trading one bond for another. That reduces the need to trade substantially, and has a knock-on effect upon liquidity
The number of currency pairs it is possible to trade pales in comparison to the number of individual corporate bonds available to trade. The frequency of credit trading for any given instrument is correspondingly limited, and price formation far less straightforward than in currency markets.
All of this makes it far harder to build a scale, high volume trading operations in corporate debt markets than in FX trading.
Nevertheless, technology is changing the credit market. The complexities of corporate bond as instruments are increasingly being tackled through the smart mapping of the issued debt and the way it is traded, facilitating the capacity to trade credit low or even no-touch by major firms.
It may be true that buy-side trading desks find the management of credit trading for different funds impossible to trade with the same facility that they execute equity and FX trades, but market makers are facing different pressures.
Supporting clients both directly and through the medium of trading venues allows them to build pipes of order flow that are far more easily homogenised and managed at scale.
With the largest US banks and electronic market makers proving highly effective at handling liquidity for clients, it may well be that the sell-side continue to develop an FX-like model in corporate debt.
