Banks are stepping back from taking risk in high yield trading. Trading in a risk-off environment in normal circumstances can be challenging as spreads widen and volumes decline.
“Gone on the days where you can say, I’m looking to buy US$20 million, can you do half and work half?” says one trader. “It is more likely someone will bid US$1 million and offer to work nine.” Consequently, buy-side traders are worried about showing their full size. Not only are banks showing less risk appetite, the turnover on sell-side trading desks has had an impact with newer sales traders unlikely to ‘swing the bat’ when they land a new seat, a trend that has increased over the last 12-18 months.
In the US markets, TRACE volumes for high yield trading saw a 2% decline in volume from 2022 to 2023, suggesting a limited change in activity despite this withdrawal of risk. However, access to new sources and routes of liquidity may be helping out the HY buy side market. While investment grade trading is proving easier to make low touch and therefore offers lower margin, HY trading offers better returns for firms generating revenues by trading rather than investing, allowing alternative liquidity providers to step into the breach according to some market participants.
Firms including Millennium and Brevan Howard are cited as potential systematic price makers in HY bond markets, albeit via trading platform so they have no client relationships with other buy-side firms. By trading in size, and frequently, they are one possible counter for the drop off in traditional dealer activity. On quiet days, one source reported they could be up to 60% of the market.
In addition, the indexation of high yield bonds has built an entire liquidity profile around the create/redeem process for exchange traded funds (ETFs) alongside portfolio trades, both of which mitigate the illiquidity of bonds either through the transfer of a basket into a more liquid exchange traded fund, or by balancing the cost of taking risk on a few bonds in a list with the value of taking others in the list and spreading the cost.
The latter are both supported by banks as well as alternative liquidity providers allowing traditional sell-side to step in with liquidity support in non-traditional ways. Where a handful of banks had this capability a few years ago, now most seem capable of doing it. Most traders noted that spreads have been tightening, and that has been making it easier to find liquidity at the right price for buy-side traders. With rates holding issuance has been strong adding to market liquidity.
It seems that in a risk-off environment – assuming volatility is not too high – electronic trading is allowing investment traders to reach out and find the other side to a trade, despite the worsening quality of traditional trading paths. As an aside, there may also be a consequent growth area for dealers, as loan trading roles are apparently multiplying, taking some of that former HY workforce.
©Markets Media Europe 2024
