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”

Bloomberg Businessweek (North America) - - Contents - �Katie Lin­sell and Claire Bos­ton Edited by Pat Reg­nier

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,

Credit Suisse,

“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.

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