Void in Treasury Market-Making Being Filled by Alternative Liquidity Providers, Study Shows

Oct 13 2015 | 5:15pm ET

More than 50% of top U.S. Treasury dealers have stopped actively making markets on interdealer platforms, according to new research from Greenwich Associates. The report outlines dramatic changes to a market that previously saw all leading dealers perform this function. 

Stepping in to fill the void, according to Greenwich, are principal trading, non-bank entities that are making markets both within the major trading venues and via bilateral relationships.

Amid broad concerns and competing data about bond market liquidity and the impact of crisis-era legislation on dealer market-making activity, Greenwich Associates sought to better understand how changes in technology, regulation, business models, and market practice are altering the structure of the U.S. Treasury market since the so-called flash crash in 2014.

To do so, the firm interviewed 103 U.S. institutional investors active in U.S. Treasuries, 13 dealers that collectively handle nearly 80% of all client trading in U.S. Treasuries, and six of the highest volume principal trading firms in the U.S. Treasury market.

The results, published in a new report entitled U.S. Treasury Trading: The Intersection of Liquidity Makers and Takers, show the top five dealers in U.S. Treasuries now handle 60% of investor trading volume, up from 44% in 2005. However, of the top 10 firms by trading volume on major inter-dealer platforms, only two are primary dealers of U.S. Treasuries. The balance is made of non-bank liquidity providers, primarily firms committed to making markets and recently described in October's Joint Staff Report issued by regulators as “principal trading firms (PTFs)” for their role in providing incremental liquidity. 

Greenwich also found that 12% of investors say they are either already trading with non-bank liquidity providers, or plan to in the coming months.  Given that a considerable amount of PTF trading in the U.S. Treasury market is done on anonymous platforms, the number of investors interacting with their liquidity is likely higher.

The study results show the market structure is being altered by new technology that enables new business models and trading mechanisms. Overall, about 20% of the liquidity providers participating in the research study, including four top 20 banks, provide direct streams to other dealers as well as customers. Some dealers are thus starting to work with, rather than against, market makers – the study found that 35% of the top 20 dealers now consume at least one PTF direct-pricing stream and execute roughly 25% of their traditionally interdealer flow through those channels.

“These changes are part of an ongoing evolution of market structure in which new business models and trading mechanisms are blurring the lines between liquidity makers and liquidity takers,” observes Kevin McPartland, head of market structure and technology research at Greenwich Associates, and author of the report.

Based in Stamford, CT, Greenwich Associates is a provider of global market intelligence and advisory services to the financial services industry.

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