Centralising Bond Trading

Abstract

The majority of bond trading around the world takes place in over-the-counter (OTC) markets where liquidity is provided by a relatively small number of financial institutions (dealers), who use their balance sheets to intermediate trades. This is in stark contrast to stock markets, where trading is mainly done on exchange-based central limit order books (CLOBs), which are fully transparent and facilitate all-to-all trading. Why is there such a discrepancy between bonds and stocks? And could more bonds also be traded on all-to-all platforms, whereby any market participant (including dealers) would provide liquidity in a more transparent and competitive environment? This report argues that further centralising bond trading, by encouraging larger parts of the bond market to move onto transparent all-to-all platforms, such as exchange-based CLOBs, is not only feasible, but will also likely improve bond market functioning and will benefit the wider financial system. In particular, it would render bond markets fairer and more competitive and would reduce execution costs for most market participants, especially retail investors. All the while, it would likely render bond markets more resilient to stress. However, such a transition is unlikely to happen without changes in the current market environment, including regulation, and it may also have to be gradual to avoid market disruption. For this reason, we articulate specific proposals that we believe could constitute a roadmap to help bond trading become more centralised, or at least stimulate debate about how well bond markets function, distinguishing as appropriate according to the characteristics of bond issues. Our analysis has benefited from discussions with market participants and from the results of a survey conducted with exchanges around the world.

Keywords: bond markets, all-to-all trading, market transparency

JEL Classification: G14,G15,G18