Bond Market – Secondary Market
After the initial sale of a new issue in the primary market, fixed income securities holders (i.e. investors) may trade the securities throughout the life of the security in the secondary market. The secondary market allows holders of fixed income securities to sell their position rather than hold them to maturity and allows investors to purchase existing fixed income securities for their portfolio.
Fixed income securities are generally traded over-the-counter (OTC) through a decentralized dealer network. This contrasts the equity markets, where securities can be readily traded on centralized exchanges. In particular, sales and trading desks at investment banks (dealers) facilitate transactions between buyers and sellers in the secondary bond market. In the secondary market, dealers can be:
- Counterparty – dealer acts as the counterparty when an investor is interested in purchasing or selling a bond. The dealer holds the inventory and in turn seeks a counterparty for the bonds in their inventory.
- Agent – dealer acts as an intermediary that connects buyers with sellers of bonds. The dealer does not take ownership of the bond and charges a commission to connect the two parties.
Electronic trading platforms, usually in the form of interdealer networks provide an alternative marketplace to trade fixed income securities.
Trends in bond market liquidity
Liquidity in the secondary bond market is often characterized as broad but shallow due to the nature of key institutional fixed income investors, particularly insurance companies and pension funds, as they employ a “buy-and-hold” strategy. An excerpt by BlackRock addressing liquidity trends in the global bond markets:
Bond markets are changing as a result of a number of different factors. To start, Central Banks have been employing extraordinary measures to maintain low interest rates for an extended period of time. Bond issuance has increased as issuers take advantage of borrowing at historically low rates. At the same time, de-leveraging across the financial system is ongoing and broker-dealers’ trading inventories have been markedly reduced, mainly due to the elimination of proprietary trading resulting from regulatory reforms such as the Volcker Rule in the US. Broker-dealers continue to make markets in fixed income; however, their market making activities are more constrained than before. Taken together, the result is that the number of bonds outstanding has significantly outpaced increases in trading volumes, therefore resulting in lower turnover (volume as a percentage of outstanding).
- Addressing Market Liquidity (July 2015) by BlackRock