Here's Why It's So Hard to Fix the Corporate Bond Market

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway. My co-host, Joe Weisenthal, is away, which means I get a chance to talk about one of my all-time favorite topics, which has to be bond market structure, and particularly the evolution, or sometimes lack thereof, of that structure and the way that a massive, massive market is actually traded.

So when people think about the corporate bond market, I think there's a tendency to think way back to sort of liars poker era corporate bond trading. Like this was the big business on Wall Street. People made lots of money from it. You had certain personalities that were tied to it, and it was sort of old-fashioned, the way bonds were traded. And then fast forward to post-financial crisis, the 2010s, and surprisingly, even as the stock market had largely electronified, the corporate bond market was still pretty much operating like it had in even the 1980s. Trades done by phone, some trades done by fax, kind of amazingly. And then if you fast forward to 2020, 2021, we've spoken a lot on the show about the idea of the pandemic forcing or increasing the rate of digitalization in the broader economy, the idea of everyone ordering stuff online and more things just moving to the cloud and computerized processes.

Interestingly, it seems like the pandemic has had a little bit of that effect on the corporate bond market as well. So we've actually seen the proportion of corporate bond trades that are electronic go up. The most recent research I saw, think it was from Greenwich Associates, had electronic trading as a proportion of overall investment grade corporate bond trading at about 40% of the total.

That is up from, I think, 30% at the beginning of 2020 and up from a minuscule 1 10th of total trading in 2011 So that tells you how far we've come.

But of course, there is much further to go and there have been efforts to reform corporate bond trading the way it's done for many, many years now. And one of the most interesting developments in that space has been the establishment of the Fixed Income Market Structure Advisory Committee by the SEC. This was created back in 2018 with the intention of improving the fixed income market and encouraging its development. So today, I'm very pleased to say that we are going to be checking in on what's going on with the corporate bond market, whether or not FIMSAC has been able to fix it or at least improve it moderately. And we're gonna be doing that with the perfect person. We're going to be speaking with Larry Harris, who was on FIMSAC, so on the SEC committee. He's also the former chief economist at the SEC. He was there from 2002 to 2004 And he is currently the Fred V. Keenan Chair in Finance at the USC Marshall School of Business. So Larry, thanks so much for coming on the show.

Larry Harris (3:31)

Oh, it's a pleasure to be here.

Tracy Alloway (3:33)

So maybe just a first question. I mean, it sounds like you have been in the sort of trading and market microstructure space for a very long time. Is this something that you've always been following?

Larry Harris (3:46)

Yes, I've been working in market microstructure pretty much from the beginning of the academic field, and now probably 40 years.

Tracy Alloway (3:56)

So given your expertise, I have to ask, what is it about corporate bonds that seems to make them a little bit more stubborn when it comes to things like electronic trading, standardization, other efforts to improve liquidity? It feels like the corporate bond space, despite people trying to evolve it for, I mean, decades now, it feels like it's definitely an uphill battle.

Larry Harris (4:26)

Tracy, that's a great question. If you listen to the vested interests in the bond market, they'll tell you that bonds are just simply different. They're different from equities, they're different from options, they're different from futures. And they say that the differences are what makes the market structure different. Of course, they don't often articulate exactly what those differences are. So often they'll tell you that they're different because there are so many bonds. But there are even more options that trade, and they trade in exchange markets, and they trade pretty well. They'll tell you that they're different because they're so risky, although equities are more risky per dollar of principal than our bonds. So it's a little hard to understand this question on its face. We're gonna have to dig deeper. But as long as we're starting with some history, as you started history, you started around the 80s. I'd like to push it back much further.