Liquidnet sees electronic future for gray bond trading

TP Icap’s Liquidnet is electronifying one of the last bastions of voice trading in European fixed income: the gray market.

Trading ‘in the gray’ refers to the act of buying or selling a bond before it has been formally issued. Portfolio managers have long traded bonds among themselves in the days after an offering has been announced, but before the securities have been issued.

The gray market can help investors manage both an over- or under-allocation from the banks bookrunning a bond offering. It also gives speculators that might think the bond is being brought to market cheaply an opportunity to buy in.

But while this market has historically centered around manual processes—traded over-the-counter either by phone or IB chat—TP Icap is beginning to see it make the transition to electronification. Volumes on the interdealer broker’s agency execution platform, Liquidnet, have more than doubled in the first quarter of 2024 to $3.5 billion, compared with the fourth quarter of 2023, propelled by surging bond issuance from corporates and governments.

When you’re running a new issuance order book, you’re reliant on the issuance cycle. As it has come back, more volume is being traded

Nichola Hunter, Liquidnet

“The growth of our new issues order book has been fairly exponential,” explains Nichola Hunter, global head of sales and trading, fixed income at Liquidnet.

“We’ve had it live for a couple of years, but it’s really only in the last 10 to 11 months that we’ve started to get traction and see the growth. The timing has been good because the new issuance cycle has been very active.”

US corporate bond issuance hit a record high in Q1, growing 81% to $628 billion as corporates take advantage of historically tight spreads, data from the trade body Sifma shows. Meanwhile, the difference between corporate credit yields and the risk-free rate was trading at around 90 basis points for March and April—the longest period of sub-100 basis point spreads since 2021, according to research from Barclays.

With the Federal Reserve’s rate-hiking cycle at a close, investors are piling into bonds, hoping prices will begin to rise when the cuts begin.

These market conditions play a key role in pushing traders towards electronic gray market trading.

“When you’re running a new issuance order book, you’re reliant on the issuance cycle,” says Hunter. “As it has come back, more volume is being traded.”

Liquidnet, acquired by TP Icap for $700 million in 2021, launched its New Issue Trading protocol that same year—the first electronic platform to trade new issues in Europe. With around 250 different users active on the platform, traders include institutional investors, hedge funds and prop traders.

Liquidnet says bonds representing around 85% of new issuance in the Emea region have been traded in the gray on the New Issue Trading platform.

Just over a third of its gray market volumes are from government bond trading, such as a three tranche Israel deal that traded in the gray earlier this year. Another third is made up of financial names, and the rest is other types of corporate credit and high-yield bonds.

Sovereign debt traded in the gray on the Liquidnet platform has an average ticket size of $900,000, while the corporate credits ticket sizes on the platform tend to hover around $500,000.

We’ve seen a big uptick in government bond issues being traded in the gray recently

David Everson, Liquidnet

“People tend to think that as it’s called the gray market it’s opaque and difficult to price accurately,” says David Everson, head of fixed income trading, Emea, at Liquidnet. He argues that pre-issuance trading is “much more liquid” than might be imagined, and is becoming much easier to price due to electronification.

“We’ve seen a big uptick in government bond issues being traded in the gray recently, which is helping to increase our average ticket size,” he says.

A bond traded in the gray does not settle until after it has been priced. Hypothetically, if a company or government decides to scrap a capital raise between an announcement and an issuance, all gray trading in that credit would be wiped.

“Essentially what you’re doing if you’re buying a bond in the gray at that same issue price, plus 20 cents, is you’re agreeing to buy those bonds on the day of issuance at 20 cents over where the bond prices,” explains Everson.

Bonds stay on the Liquidnet new issue platform until two days after issuance. Liquidity then moves to other venues, such as Tradeweb or MarketAxess for investment grade deals, or Liquidnet’s own dark pool, a secondary market fixed income venue.

Order management

Everson attributes Liquidnet’s success in the gray market to the platform’s integration with buy-side order management systems (OMS).

The platform receives new issuance announcements from around 30 banks, and puts them onto a dashboard that sits on clients’ trading screens.

“In the past, those announcements have been non standardized… sitting on a buy-side trading desk, you’d get an announcement from maybe 10 different banks that are on the deal. They’re not standardized. They’re all coming through at different times. You might be getting them via chat or a phone call.”

Introducing an electronic solution allows us to aggregate liquidity in what has been quite a fragmented and opaque market

David Everson, Liquidnet

Electronic pre-issuance trading is now a much easier technology lift than it once was because of the emergence of the Financial Instrument Global Identifier (Figi), a code that can act as a temporary placeholder to identify a to-be-issued security. Once a security is issued, the Figi is replaced with an Isin internationally or a Cusip in North America.

Giving the gray market product a temporary identifier saves significant man hours, Everson claims, compared with manually adding a shell for a to-be-issued bond into an OMS.

“Introducing an electronic solution allows us to aggregate liquidity in what has been quite a fragmented and opaque market. That brings transparency, and in theory that should reduce execution costs,” says Everson.

Credit boost

Everson’s gray market trading is a small part of Liquidnet’s wider business, which includes a well-developed set of dark pools for equities trading. Hunter’s focus is on expanding the unit’s fixed income dark pool, by increasing participation from sell-side trading desks.

Earnings before interest and tax in the Liquidnet credit business that Hunter oversees—which includes the gray trading venue—jumped fivefold in 2023 to $10 million.

Transactions in Liquidnet’s all-to-all dark pool are predominantly less liquid US dollar-denominated high yield debt and emerging market bonds.

More than three quarters of Liquidnet’s traded notional last year (normalized to USD) was in high yield—with 54% of total notional traded being specifically USD-denominated high yield and 22% being euro-denominated high yield. Resting liquidity on the platform hovers around $15 billion a day. However, only a small portion of this figure is actually transacted, because resting liquidity counts all the bonds that are available to be bought or sold. A match is only made if those needs are aligned, and a trade only made if clients agree to trade in the dark, rather than on a more traditional request-for-quote (RFQ) platform.

Like the gray market trading order book, Hunter says Liquidnet’s integration with buy-side OMS software provides useful functionality. Client blotters are automatically scraped for active orders: if a buyer and a seller match, they are linked together to negotiate a price, with Liquidnet providing an independent reference price. Neither party know the identity of the other—Liquidnet is the counterparty to every trade.

“We sweep their blotters and we capture their order inventory,” she says. A blotter is a temporary ledger of trades made, usually over a single day.

Blocks traded on the dark pool typically start at around $2 million, with up to $14 billion of resting liquidity connected to the platform.

Hunter was sitting at the desk a few months ago when a colleague turned to her and asked, ‘Where is Papua New Guinea?’.

Papua New Guinea issued a rare $500 million 10-year USD bond in 2018, a good example of the kind of esoteric securities that would be nearly impossible to source through dealer inventories on an RFQ system without significant price impact.

“That illustrates the uniqueness of our venue,” says Hunter, “along with the value we provide in the hunt to execute some of the most illiquid bonds on the planet across HY and EM.”

Editing by Joe Parsons