Unlock the liquidity of corporate bonds with AI

Artificial intelligence could be on the verge of unlocking previously unattainable levels of liquidity in the corporate bond market.

The U.S. corporate market has more than $ 9.8 trillion in bonds outstanding, but less than $ 38 billion is traded in the secondary market every day. This discrepancy is widening as an increase in new issues far outstrips growth in secondary trading.

The lack of a central limit order book or real-time trade reporting in the OTC market makes pricing difficult and sometimes impossible. On average, 80% of corporate bond trading activity comes from just 20% of the bonds outstanding. Many bonds are rarely traded or not traded at all. In fact, most investment professionals hold a large percentage of their portfolios in trapped bonds, which means they cannot find natural buyers or sellers for the securities at market clearing levels.

The combination of illiquidity and poor pricing often leads to a significant impact on the market and poor prices for companies looking to buy or sell bonds. These conditions also cost time and effort: portfolio managers spend a lot of time creating trades they would like to execute, only to find insufficient liquidity to complete the trades at their target prices.

Historically, the “backstop” liquidity provided by broker-dealers mitigated the worst of these effects for market participants. However, a decade ago regulators tried to shore up the banking system after [WP1] the global financial crisis [WP2] increased demands on the capital reserves of banks. This move prompted banks to reduce the holdings of corporate bonds they had used to build markets and provide liquidity on a market-wide basis.

Liquidity levels have never fully recovered and market participants are still feeling the effects today. Although the growth of electronic trading to around 40% of the trading volume of the corporate bond market has helped create liquidity for smaller trades, market participants are struggling to complete larger trades. In many cases, executing a large trade in corporate bonds means seeking liquidity from multiple counterparties, which creates the risk of information loss.

Create liquidity with next-generation technology

These challenges have created tremendous incentives for investors to seek new sources of liquidity and for brokers and sellers to invest in innovative technologies that can make the market more efficient. These investments are starting to pay off.

New technology platforms are able to monitor and report the liquidity conditions of corporate bonds in real time. By using AI to process input from both the buyer and seller side, they can tell a portfolio manager how likely they are to make a particular trade and send alerts to notify users when potential ones are There is liquidity for trading. This gives market participants a chance to gauge liquidity without shaking their hand by asking multiple traders.