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Momentous news: the European bond market has gone electric.

Compared against equities (and nearly every other avenue of finance) corporate bonds markets have been slow to digitise. Lumpy liquidity combined with post-GFC risk aversion to keep much of the market high-touch. But change accelerated in recent years, with the popularity of ETFs spurring growth in portfolio trading that ever-improving algorithms could be trusted to manage.

Measuring this progress has been tricky, however. While transaction data is made public under Mifid II law, there’s no single post-trade repository and no standardised reporting format across Europe’s myriad corporate bond trading venues and platforms.

For this reason, Barclays analysts have been building a consolidated tape for corporate bonds. Today they announced the first findings.

As of April, 50 per cent of European investment-grade volumes and 41 per of high-yield volumes were executed electronically, Barclays told clients. That’s up from 41 per cent and 37 per cent respectively in November 2022:

Measured by ticket rather than volume, 60 per cent of all transactions for April were electronic.

Migration has been quicker than many participants expected. Early in the decade, when portfolio trading was emerging in importance, deals were still organised via email or Bloomberg chat to be executed off-venue. Improvements to platforms such as Tradeweb and the advent of all-to-all trading have since reduced the need for human intervention and cut the per-trade transaction cost by an estimated 20 to 40 per cent, Barclays says.

But while algorithms work well on the small trades that account for 60 per cent of European bond market activity, they’re not yet trusted with big and complicated stuff.

Only liquid, recently issued bonds with a large outstanding basis and a high credit rating are considered sufficiently low-touch to be fed into the system. So while the median European trade is now electronic the category still only accounts for 30 per cent of total volume, Barclays finds.

And whenever markets go haywire, dealers revert to voice:

[W]e considered two different types of volatility events: an increase in the idiosyncratic (bond-level) volatility triggered by credit rating downgrades, and an increase in aggregate volatility, proxied by the VSTOXX index. In our sample (November 2022 – April 2023), while electronic volumes remained virtually unchanged in the 10 days before and after a downgrade, the entire increase in trading activity brought about by the sell-off after a downgrade was supported by voice trading.

In percentage terms, the share of electronic trading dropped from 59% before a downgrade to 46% afterwards. The effect is even more pronounced for “fallen angels”, for which the share of electronic trading drops to 26% of total volumes after the downgrade. Once downgraded, “fallen angels” are removed from benchmark IG indices, and hence, from institutional portfolios constrained to invest in only IG corporate bonds (eg. insurance companies), exerting higher selling pressure than is the case for downgrades within IG.

Finally, comparing periods of low and high aggregate volatility, we find that the cost benefits of electronic trading vis-a-vis voice trading were 10-15% lower. Taken as a whole, our results suggest that when volatility spikes and volumes tend to be one-sided, investors turn mostly to voice trading and rely on their relationships with trading desks to recycle the risk.

For as long as markets stay orderly, says Barclays, the shift to electronic trading can “free up capacity at trading desks and allow individual line item traders the time to focus on more difficult, larger trades in illiquid bonds.”

Or maybe it’ll result in widespread job cuts, creating a capacity bottleneck that will only show through when markets turn disorderly. The pace of change in Europe suggests we might find out sooner than expected which path we’re on.

Further reading:
Bond trading 3.0 (FTAV)

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