Institutional investors are open to a range of new solutions to counteract diminished liquidity in the market for off-the-run U.S. Treasuries, according to a new report,Off-the-Run Treasury Trading: Understanding the Evolving Market Structure, from Greenwich Associates.
Greenwich Associates research finds that when a bond goes from on the run, or OTR, to off the run, or OFTR, transaction costs rise an average of 40%, the length of time to execute increases by one-third, prices increase by 15%, and the market depth decreases by nearly 37%. Although liquidity has declined across the Treasury market, the reduction seems particularly severe in OFTR as two-thirds of research participants have seen a decline in liquid OFTRs, and nearly all (83%) saw a decline in illiquid OFTRs.
“Market participants must increasingly accept current market conditions as the new normal and adapt their trading and investing practices as needed to ensure they can find the liquidity they need at a price they are willing to pay,” says Kevin McPartland, Head of Market Structure and Technology Research at Greenwich Associates, and author of the new report.
Possible Solutions to Illiquidity in the OFTR Market
Investors could begin to see improved executions by better understanding explicit and implicit trading costs. With most of the focus today on bid-ask spreads, other costs are often missed leading to sub-optimal executions. An examination focused on the underlying market structure encompassing trading platform fees, market impact costs, direct commissions, and other implicit costs can lead to a possible solution of how trades are executed.
Both the buy side and sell side see the inherent value in all-to-all trading. All-to-all trading is possible via several trading protocols—auctions, dark pools, order books, and even RFQ. Finding the right combination of these various protocols with an adaptive market structure should benefit a wide variety of trading strategies and user types.
Ultimately, the best way to increase liquidity is to expand the number of participants in the market via all-to-all trading and other incentives for providing liquidity. “Better incentives for dealers to hold inventory for the sake of providing liquidity, coupled with a transformation of traditional dealer/investor roles via all-to-all trading, will see market depth deepen and spreads tighten even without the pre-crisis risk-taking that brought us to where we are today,” says Kevin McPartland.