By John Manning – john.manning@internationalbanker.com
The bond market has been suffering over the past few years. BlackRock, the biggest money manager across the globe, recently published a white paper in which they called the corporate-bond market “broken”. Over the past few years, the size and scope of all types of bond-market trading activity across the globe has undergone an overhaul as a result of the global financial crisis. The change in activity has furthermore continued due to the number of restraining regulations that have since been put in place to reduce volatility in the marketplace to protect against similar financial crises in the future. Further to this, according to RBS (Royal Bank of Scotland), a European corporate bond trades at an average frequency of only once a day, compared with the rate of almost five times a day 10 years ago. This has left the recovery of the corporate-bond market slow and lacklustre, and it has also led to the consideration of a number of projects and ideas to revamp the market to develop some sustainable growth and momentum that may create beneficial knock-on effects through the stimulation of the wider economy.
When it comes to trading in the fixed-income market, information is a vital component of the decision-making process. Traders’ knowledge of market participants’ inventories can be a key part of trading, and this information certainly makes trading easier. In autumn of last year, a group of banks worked together to launch a collaborative bond platform offering. The name of this bond project is Project Neptune, and it has been set up with the goal of boosting bond trading and wider market activity. Savvy market participants, economic advisers and investors across the globe have been working with senior bank executives on the venture, which has been set up in particular to bolster corporate-bond trading activity within the US and European market regions. Increased dealer activity, which has been severely stymied over the past five years, has the potential to help businesses grow through increased investment, which has the potential to create jobs and help wages and incomes grow, stimulate spending and consumer activity, and help the macro-economic climate develop. During the development stages of the Neptune project, there have been 28 key participants made up of 16 Europe-based money managers alongside 12 lending groups and companies. These participants have been working closely with Etrading Software Ltd to launch a system that will allow for more collaborative work in the bond-trading arena—providing key information and building-block-type infrastructure that will help deals to be put together and be executed more easily between banking and investor parties. The Project Neptune platform and protocol provides a standardised set of language commands and procedures to help facilitate increased bond-trading activity. In addition, the project includes a messaging system that will also help bring deals to fruition and create connections and liquidity.
This type of platform and protocol will hopefully restore some activity and interest in the bond market, which has been dwindling not only due to the economic crises and regulatory changes to trading activity but also as banks have had to adapt to an industry climate in which balance sheets must hold an increased proportion of a certain calibre of capital. As banks seek to meet increasingly stringent balance-sheet tests, certain banking and financial institutions have in fact had to cut back their holdings in a number of bond, and other asset class, positions. The innovative Project Neptune venture has been specifically designed to provide traders with a forum for advertising bonds without revealing more sensitive buyer and seller data. The creative plan has been backed by a number of key asset-management firms within the US and Europe. Based on a connectivity framework of mathematical and technical systems, Project Neptune has been backed by a number of bulge bracket US banks such as Morgan Stanley and Goldman Sachs. Other banks and asset managers involved in devising Project Neptune include BNP Paribas, Aviva Investors, Credit Suisse, JPMorgan, Axa IM, Standard Life Investments and Nordea Investment Management.
The project will create a network of these key trading institutions and will allow for easier deal-making and increased amounts of interactions. Developed by the FIX Trading Community, a London-based trading-protocol group, the Neptune Project has been gaining wide support from banking and financial-services industry participants and institutions. FIX is the language the bond market will use and that currently acts as a widely adopted protocol for carrying data and trading messages around equity and bond markets across the globe. The project is recognised as a realistic attempt to address industry fears of contracting fixed-income market liquidity and has incorporated a suitable degree of technological detail, skill and effectiveness towards addressing the problem in a sustainable and efficient manner. The combination of rapid technological development market-wide across all asset classes and activity within the tougher environment in economic and regulatory conditions has further placed a squeeze on the fixed-income market over the past few years. A technological overhaul is due, and Project Neptune takes substantial steps in the right direction.
The bond-trading market has historically been dominated by large banks based in London’s and New York’s prominent financial districts. However, the entire bond-trading industry has been evolving in shape and structure given the new technological, economic and regulatory climate. This new market structure is forcing the larger institutions—traditionally the key dealer banks and institutions—to consider their balance-sheet and asset-holding structure more closely and in a much more restrained manner. These institutions have been forced to hold larger amounts of capital on their balance sheets and reduce debt-instrument inventory to meet regulatory rules and requirements. This is beginning to level the playing field of the bond-trading market—with larger institutions reducing their dominant position, and smaller players constituting a larger proportion of market activity. To be specific, bond inventories have contracted 70 percent for the major bond dealers in the marketplace when comparing current holdings to the time before the global financial crisis, according to Alberto Gallo and his team at Royal Bank of Scotland Group Plc in London. However, at the same time, the total outstanding stock of fixed-income assets has grown to twice its size as both businesses and governments have sought to take advantage of a vital opportunity of the low interest-rate environment in which they can sell debt affordably, if not cheaply, in certain cases.
The previously unseen market conditions we currently are experiencing have created a substantial imbalance in the bond market, and although a number of other attempts have been made to stimulate market activity and boost liquidity, they have to date proved ineffective. The alternative solutions have included boosted investment and efforts toward electronic trading activity in the past, but the key hindrance to development from this angle has been one of there being a mismatch between the protocols and platforms between various banks and financial institutions. This has created frictions between market participants and has hampered the potential for increased activity to flourish and likewise hampered the development of momentum—crucial in rebuilding the sector. The involved parties have struggled to share information, and Project Neptune addresses these concerns head-on. Where in the past, asset managers would have to trawl through thousands of emails a day regarding bond inventories, Project Neptune streamlines the information so that it may then be used for effective decision-making and activity. As part of the project, banking parties on the sell side of a transaction and asset and investment managers on the buy side are able to communicate through a common computer language and system to pass information smoothly and accurately between both sides.
Project Neptune has created an agreed-upon standard of trading language and symbols within one system to gather and streamline data in timely and effective formats to create an efficient mechanism for the exchange of inventory data between market participants. This allows different systems to interact and seek opportunities through inventory data, which will lead to more trading activity and boost liquidity. The project devisers have already outlined plans to expand the Project Neptune scope, capabilities and network in the future—looking to broaden the benefits of clearer and quicker data exchange to stimulate and streamline market activity and efficiency in various other areas of capital markets.
Not all market participants are in support of the Project Neptune venture. In particular critics have pointed out that it will act to restore the historic imbalance in which large bulge bracket banks and financial-services institutions dominated the bond-trading marketplace. The rise of electronic trading over the past few years has given smaller institutions, including those that connect buy-side firms to buy-side firms, a slice of the larger profit-making trades. These critics have suggested that Project Neptune has been set up to a significant degree to remove this element of healthy competition from the market.
The first phase of the project will focus on helping dealers provide investment managers with information regarding inventory holdings, and later the venture will look to link investors to each other and provide greater functionality. Each bank is set to pay $48,000 each for the first phase of the Neptune Project protocol—which will cover consultancy work for the rollout, which is initially planned for Europe and is likely to take a number of months for delivery. Banks have noted that there has been a stream of similar smaller ventures launched over the past few years—with a new project being launched every few months or so—but none have managed to develop momentum and uptake effectively. However, the backing participants of Project Neptune are optimistic that this platform will gain a foothold as it is being underpinned by a more robust system and software-development protocol that key banks and asset managers have gotten behind to support. The $48,000 start-up cost may appear small initially compared to the exorbitant amounts banks are paying for various other technological ventures and projects. However, project founders have noted that they are looking for a collaborative, long-term relationship that is effective for all parties involved in the project goals. The key at this time for the project is to create an increased amount of, and forum for, pre-trade dialogue between buyers and sellers—to facilitate a network to link parties involved in bond trading. The network will also allow for a number of existing trading platforms to connect and share information with the project to help ease take-up for various market players.
Since the global financial crisis more than five years ago, investors have been experiencing a growing disparity between old and new bonds when it comes to their trading volumes. There has been high turnover in newer bonds due to the low interest-rate environment leading to cheap borrowing, and this has driven a boom in issuance that has doubled the size of the corporate-bond market in recent years and narrowed investors’ attention on the newest debt. However, in the meantime, the growth of the overall bond market has meant banks’ holdings are now a reduced proportion of the amount of debt outstanding in the aftermarket (the market in which bonds trade after first issuance). Wall Street’s bond inventories are now two-thirds less than pre-financial crisis levels. Project Neptune seeks to address this imbalance by allowing inventory to be more efficiently utilised. A further key selling point of the Project Neptune venture will be the ability of banks to access an alternative platform to reach and communicate with corporate-bond investors. Currently one option for carrying out this function is through the Bloomberg LP terminal, which comes at a cost of approximately $20,000 per annum. By providing an alternative to Project Neptune, a certain degree of efficiency-boosting and cost-reducing competition will be brought to the market for accessing bond investors in this way.
For now, the Project Neptune venture seems like a promising solution to a problem that has pervaded the market for more than five years and continues to do so to an increasing degree. The plans to create a bond network and improve liquidity in the corporate-debt market have garnered a sufficient amount of interest and support from key market players, and the challenge now will be to roll out and implement a system that will no doubt face a wide range and large number of technological, data and system-based hurdles. The feasibility study of the project has recently been completed, and only by addressing any potential pitfalls head-on and with timely, effective solutions will the Project Neptune protocol and network succeed in its aims. If it does succeed, it will be of great value to the marketplace and wider global economy—providing liquidity and boosted activity in any asset class is a highly valuable outcome in the currently vulnerable and volatile marketplace.