Bond traders: From Masters of the Universe to order takers
How high-yield traders went from being risk jockeys to order-fillers “Things aren’t going back to how they were”
Junk-bond traders at major banks were some of the savviest people on Wall Street. Maybe they still are—but to do their jobs these days, pretty much all many need is a decent list of contacts.
Not so long ago, the traders’ most important task was to take profitable risks on behalf of their banks. After buying a few million dollars’ worth of highyield bonds, a trader would decide whether to hold them for a little while or flip them fast, based on an analysis of where prices were headed.
Things have changed. In 2015 about 70 percent of major banks’ junk-bond trading consisted of nothing more than linking up buyers and sellers, according to a recent estimate from the consulting firm Tabb Group. A decade ago the figure was 20 percent. That kind of middleman service is less risky for the bank and also offers fewer profit opportunities for the traders.
Why the shift? Many on Wall Street point to new rules. In the wake of the financial crisis, global regulations known as Basel III have made it more costly for banks to hang on to risky assets. The Dodd-Frank financial reform law in the U.S. sets limits on how much of their own money banks can wager in the markets. These changes have magnified the effect of another rule, which came into force more than a decade ago, that requires U.S. banks and brokers to report every trade they execute within minutes, making it harder to keep an informational edge over rivals.
“If you’re a high-yield risk taker at a bank, you’re thinking, ‘My hands are tied, I can’t take risk, and it’s so transparent, no one lets me make money.’ It’s very frustrating,” says Thomas Thees, a former head of North American credit trading at Morgan Stanley who oversees fixed-income trading at CastleOak Securities. Banks including Morgan Stanley,
“It’s harder than it used to be to transact without disturbing the price of the market. If it’s not an urgent trade, you could take weeks to completely sell a position”
and Nomura Holdings have been shrinking trading staff.
There’s a debate about how these changes affect the overall junk-bond market. In the highflying days, the big banks stood ready to quickly buy the blocks of bonds fund managers wanted to sell. They could then break the purchases into chunks and sell them off over time. Now asset managers often have to do the work of parceling out big trades for themselves, and it can take longer—with the client’s money, not the bank’s, exposed to market swings all the while.
“It’s harder than it used to be to transact without disturbing the price of the market,” says Steven Logan, head of European high yield at Aberdeen Asset Management. “If it’s not an urgent trade, you could take weeks to completely sell a position.”
That might hurt funds when markets are volatile. If investors start to cash out of their fixed-income funds en masse, money managers could find their holdings aren’t very liquid—that is, they’d have trouble quickly finding buyers for their bonds as they try to raise cash to meet redemptions.
Not everyone is convinced corporate bond markets are less liquid than they used to be. The share of outstanding U.S. junk bonds that are bought or sold every day is in line with historical averages, according to data from the Securities Industry and Financial Markets Association, a trade group.
William Dudley, president of the Federal Reserve Bank of New York, said in a speech in May that evidence of declining liquidity is mixed. He added that lower liquidity might also be a small price to pay if regulations are making large banks and other systemically important institutions less risky.
In any case, “things aren’t going back to how they were,” says Anthony Perrotta Jr., global head of research and consulting at Tabb. He says asset managers are going to have to learn how to operate in a world where the traders at major banks have a diminished role. The bottom line The role of the junk-bond trader has changed, and that could have an effect on how easily funds can sell their assets.