The corporate bond market is critically important – it allows companies to raise capital, pension funds to meet obligations, and asset managers to find what is more important than ever… growth. The likely future of higher interest rates will create a massive requirement to recycle and rebalance debt-based funds. This will stress a secondary market that already creaks and groans through periods of uncertainty and volatility. It’s not broken, but no one says that liquidity in the bond market is easy to find and access.
In fact, the vast majority – over 90% – of corporate bonds don’t trade 10 days after issuance. Liquidity is pooled, hard to find, and expensive to explore. Every search, inquiry, RFQ, and order emits significant data leakage into a market that moves just fast enough to get away from the order initiator.
As a result, buy-side traders must come to the market with full conviction on exactly what they are buying or selling and at what price. With a vast market ($41tn in assets) and limited liquidity, this is a high hurdle. When we speak to our customers, we hear “How do I select the best counterparty with the least data exposure?” and “Why can’t I describe the type of risk I want and put that to the entire market?” We think there should be a better way.
Sell-side institutions have the answers to many of those questions. They have the market position and data to help form a price and make markets. However, they currently have no incentive to push better data into electronic platforms that sell that data straight back to them. They want to form better relationships with their counterparties on a directly connected basis. They want to reduce trade execution costs, which seem to be going only one way. At the same time, algorithmic and systematic trading gets smarter every day, increasing the volume and size of assets supported.
Nearly three-quarters of trades are still arranged over the phone, a technology invented over 140 years ago. 2021 is calling, and the market has changed. Traders need to do more with less, they need to find alpha in new places, and they need intelligent tools to find and execute on the best liquidity.
As an industry, we need to see the problems and opportunities in front of us. We have better tools and better capabilities available. We need to create a more functional secondary market for corporate bonds, especially illiquid ones.
This starts with a complete re-think of the architecture of the market. Previously, we did not have the technology to keep data decentralized and protected. The only way to organize liquidity was to put it in a centrally-accessible order book. Distributed Ledger Technology (DLT) helps solve the historic structural problem in this market of locating counterparties for illiquid assets. We can now allow users to own their data on their own node in the network, protect their orders from data leakage, and engage on a point-to-point basis with others in the market. DLT helps us keep each node in sync.
This decentralized approach to data, and a point-to-point architecture is the future of market transactions across asset classes. Bitcoin enabled individuals to move value online peer to peer, without centralizing financial control and cost in a central intermediary. Across the board in financial services, Decentralized Finance (DeFi) is spawning new digital tools, marketplaces and asset classes that can disrupt capital markets.
The next frontier is building and running a decentralized system for institutional grade, regulated markets; secure, point-to-point transactions in a regulated ecosystem.
These are the foundations upon which LedgerEdge is building a best-in-market exchange for corporate bond trading, due to launch later this year. This technology solves the age-old problem of control and clarity, which we believe traps the market in a liquidity death spiral. LedgerEdge gives users ownership and control of their data (orders, axes, holdings), labelling data throughout the ecosystem to make it clear to all users.
LedgerEdge also provides scalable connectivity across the ecosystem, so that sell-side firms can connect and stream to additional buy-side firms with no marginal cost. We’ve listened to our customers and are building what they need, adapting and building faster than anyone else in the market: under 12 months from concept to live product. We use the latest technology, fast development cycles, and our starting point of trust to constantly improve our product. Crucially, our system incorporates all the security and performance requirements for regulated, institutional markets.
However, this is just the start. We know the digital trading ecosystem is developing at breakneck speed. An exchange based on distributed ledger technology serves a dual purpose. Firstly, it allows customers to control their data flows and exposure. Secondly, it also creates an ecosystem for trading of all digital financial assets and data. This second element is critical for the future of this market.
At LedgerEdge, we believe that more assets will be issued on digital platforms. These venues will continue to improve the issuance process, better connecting issuers to investors and making the issuance workflow more efficient all the time. We believe that more assets will be managed through their lifecycle on DLT, providing more efficient asset servicing and custody. Digital assets will be smarter and more communicative with the market. Users will want to trade these assets even more frequently than they do today. With more functional exchanges like LedgerEdge, liquidity will be less of a barrier to mobility. Improved asset mobility will make a wide range of operations more efficient: posting collateral, loaning assets and managing risk, among others. Users will see value in new, blockchain-based settlement methods. Using settlement assets, users can reduce risk, cost, and time associated with one of the most expensive parts of capital markets.
Market participants will increasingly see the benefits of engagement in ecosystems like LedgerEdge and systematic trading will continue its efficient march. Market participants will put ever smarter orders into the market.
The corporate bond market is ripe for these fundamental changes. As the first DeFi exchange built for institutional, regulated markets, our use case shows there’s room for a revolution in corporate bond trading, giving users control, clarity, and better execution.