Sonali Theisen, Global Head of Market Structure & Data Strategy

Citi Global Credit & Securitized Markets

Developments in credit market liquidity

SEC FIMSAC Meeting

Jan 11, 2018
2

Agenda

Credit as a principal market

Liquidity in credit – microstructure

Liquidity in credit – macro themes

Market structure considerations
Trading in credit versus equities

3

Relative to equities, few trades are spread out 

across many corporate bonds

Bonds trade less often...

Average # trades per day

...but in larger sizes

Average trade size, $

Many more bonds than stocks

Composition of major equity indices

Unique 

securities*

Market cap/ 

Outstanding 

($Tn)

S&P 500 Equities 500 23.48

Bonds 11,990 4.35

Russell 1000 Equities 1,000 26.58

Bonds 13,083 4.75

Deutsche 

Börse

Equities 30 1.43

Bonds 5,559 0.73

Euro Stoxx 50 Equities 50 3.47

Bonds 8,173 1.44

Source: Bloomberg, Dec 2017. *Bond unique securities equals 

total count of instruments per corporate in relevant equity index.

Source: Bloomberg, FINRA, TRACE. Top 50 IG 

& HY bonds and top 50 S&P 500 equity tickers 

by volume, FY 2017.

Source: Bloomberg, FINRA, TRACE. Top 50 IG 

& HY bonds and top 50 S&P 500 equity tickers 

by volume, FY 2017.

60,430

23 16

Liquid S&P

stocks

Liquid IG bonds Liquid HY bonds

19,728

1,736,152

1,658,587

Liquid S&P

stocks

Liquid IG bonds Liquid HY bonds
Ingredients for principal versus agency-driven markets

4

Credit has traditionally relied on warehousers of risk

1. Typically standardized products

2. Smaller average ticket sizes; strong 

retail involvement due to simplicity of 

instruments 

3. Easy borrow facilitates two-way flow

4. Algorithms promote ticket 

proliferation 

5. Sustained two-way flow likely without 

market-makers to commit 

discretionary capital

6. Liquidity takers more willing/able to 

manage their own execution risk by 

breaking trades into smaller lots in 

firm orders 

7. Counterparty identity less important 

due to depth of liquidity 

8. Firm, disparate liquidity on same 

instrument across multiple venues 

1. Typically non-standardized products

2. Larger average ticket sizes; less retail 

involvement due to instrument 

features 

3. No easy borrow, particularly on small 

size 

4. Algorithmic trades not a major source 

of volume 

5. Sustained two-way flow unlikely 

without market-makers to commit 

discretionary capital

6. Liquidity takers less willing/able to 

manage their own execution risk; rely 

on discretionary capital to warehouse 

or move risk 

7. Counterparty identity more important 

due to lack of active daily trading in 

most instruments 

8. Predominantly negotiated market

Principal – Credit Agency – Equities

Participants

Instruments

Equities

Credit
5

Agenda

Credit as a principal market

Liquidity in credit – microstructure

Liquidity in credit – macro themes

Market structure considerations
What do we mean by liquidity?

6

Absolute levels and changes may be observed

Bid-offer

Depth

Immediacy

Turnover Volume

Resilience

But it is impossible to define optimal targets
TRACE

DoddFrank

Negative 

interest 

rates

Mark-tomarket 

accounting

Cumulative impact of regulation and policy is difficult to isolate

QE

7

G-SIFI

But the outcome is reduced buffers

and a loss of heterogeneity

Solvency 

2

Basel / 

capital 

rules

Mutual 

fund 

concentration

CMU

SLR

MiFID

II

Volcker

FRS 

17

SFAS 

158

Liquidity

Buyside Sellside Monetary policy

SEC SEF

MMkt

Reform

Reaching 

for yield
Market diversity has fallen significantly

8

Ownership base may seem diverse...

US corporate bond outstandings by owner, % total

The buyer base has become more homogenous

Source: Federal Reserve Flow of Funds, Haver Analytics.

*Although described as “household” in flow of funds, series likely dominated by hedge funds.

Foreign

Mutual fund / 

ETF

Pension

Bank / broker

Hedge fund*

Other

Insurance

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

90 00 10

...but 80% of buying is funds and foreigners

US corporate bond net buying, 4Q sum, $bn

-200

0

200

400

600

800

1000

1200

2007 2017

Foreign

Mutual fund 

/ ETF

Pension

Bank / broker

Hedge fund*

Other

Insurance

50%

80%

Source: Federal Reserve Flow of Funds, Haver Analytics.

*Although described as “household” in flow of funds, series likely dominated by hedge funds.

2017 data are 4Q16 through 3Q17.
Decline in dealer inventory

Balance sheet: contraction or correction?

Street holdings of credit*, $Bn

Source: Federal Reserve.

*Inventory numbers also include RMBS/ABS, which were likely much larger in 06-07.

9

After a decade of deleveraging, street inventory 

is similar to early 2000s

0

50

100

150

200

250

300

01 03 05 07 09 11 13 15 17

Total

Corp

RMBS / ABS

CP
Issuance, volumes and bid-offer continue to improve

Traded volumes up with issuance

US IG gross issuance vs secondary trading (6m sum, $bn)

10

Market is near highs in new issue supply and traded 

volumes and near lows in bid-offer spread

Bid-offer spreads are tight

Average bid-offer spread in IG cash (bp)

Source: MarketAxess Bid-Ask Spread Index (BASI), Citi.

Note that all series are derived and may not be directly comparable.

0

5

10

15

20

25

30

35

40

45

04 06 08 10 12 14 16 18

$ (new series)

€

£

$ (old series)

0

500

1000

1500

2000

2500

0

100

200

300

400

500

600

700

800

900

1,000

05 07 09 11 13 15 17

New 

issuance 

($bn)

Secondary 

volume 

($bn)

Source: TRACE, Dealogic, Citi.
Capital rules may be impacting risk transformation

11

Curve risk 

(e.g. curve steepeners)

Liquidity 

(e.g. off-the-run vs. onthe run)

Instrument type 

(e.g. funded vs. 

unfunded)

Replication 

(eg. Index 

reconstruction)

Risk 

transformation

The role of market-maker

Absorbs supply and demand imbalances by transforming risk

Capital costs have risen

Bank* RoE and change in capital estimates under old and 

new leverage ratio constraints, by business, %

Market-making has become more expensive in the 

many cases where trading requires risk transformation

-60

-40

-20

0

20

40

60

80

100

0

5

10

15

20

25

30

35

IBD

EM

Credit

Equities

Securitised

Macro / prime

Chg capital required 

(%)

RoE (%)

Old

New

Source: Citi. *Numbers derived from one particular bank but are likely to be 

representative.
Investors need more conviction to trade

12

The cost of business... 

Citi US Broad Investment Grade Corporate Index

2007 vs. 2017

Source: Yield Book, Citi. Assumes a switch into a similar bond (price, yield, maturity) assuming selling at mid-market and buying new security at offer side. 

...with $10mm to invest

Expected transaction costs for switch trade, 1yr horizon

Holding spreads & yields constant (no roll-down)

Consider the break-even horizon...

Then | 2007 break-even period = 15 days

Transaction cost = 4.03% of yield; Market yield = 5.72%

Now | 2017 break-even period = 32 days

Transaction cost = 8.63% of yield; Market yield = 3.26%

Low yields, low volatility and high transaction costs create 

longer holding periods and disincentive to trade

Then Now

Transaction Cost Scenario 12/31/2007 12/31/2017

Citi USBIG Corporates Index YTM 5.72% 3.26%

Bid-Ask 2-3 bps 2-3 bps

 Assume: Midpoint of Bid-Ask 2.5 bps 2.5 bps

Duration 6.1 7.5

Bid-Ask Cost, adjusted for duration, round trip 23 bps 28 bps

Transaction Cost as % of Par 0.23% 0.28%

USBIG Corporates Index Snapshot

Eff Duration, USBIG, Corp. 6.1 7.5

Spread to Treasury, USBIG, Corp. +197 bps +94 bps

# of Issues, USBIG, Corp. 2,936 6,185

Yield to Maturity, USBIG, Corp. 5.72% 3.26%

Market Value, USBIG, Corp. ($ bn) $1,876 $5,312

Average Life, USBIG, Corp. (years) 10.2 10.6

Then Now

Expected Transaction Costs 12/31/2007 12/31/2017

Yield Return, Gross $571,700 $325,600

Bid-Ask Cost, adjusted for duration, round trip $23,051 $28,101

Transaction Cost as % of Yield 4.03% 8.63%
ETFs – driving the market, or reacting to it? 

13

Higher ETF flows have coincided with a decline in relative 

value trading and a period of technological innovation

HY Mutual and ETF fund flows

Cumulative inflow since 2000, $bn

Contributors to the rise of passive investing 

Decline in 

relative 

value 

trading

Reduced 

leverage

Less 

credit 

dispersion

Low 

volatility & 

yields

Less 

investor 

diversity

-50

0

50

100

150

200

00 02 04 06 08 10 12 14 16

Mutual fund

ETF

Source: ICI, Citi.
14

Agenda

Credit as a principal market

Liquidity in credit – microstructure

Liquidity in credit – macro themes

Market structure considerations
Liquidity in corporate bonds is transient 

15

Agents connect buyers and sellers only when two-way 

interest exists, which can be sporadic 

...and it migrates through time

% of bonds that would have been deemed liquid* under MiFID II 

framework in 3Q13 and again in subsequent quarters, € corps

Source: Citi, Bloomberg, TRACE. Source: MarketAxess Research.

*Uses previous ESMA (Scenario 6) definition of liquidity: >2,400 trades per year, 

average daily volume of at least €1m, plus requirements on the number of days the bond 

traded and number of participants in the market.

100%

44%

25% 25%

15%

0%

56%

75% 75%

85%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

3Q13 4Q13 1Q14 2Q14 3Q14

Illiquid in 3Q13 Liquid in 3Q13

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

1 50 99 148 197 246

CUSIP count

Days Traded

CUSIPs outstanding: 29,062

Never traded: 2,698 (9.3%)

Traded ≤5 days: 9,532 (39.0%)

Traded daily: 449 (1.5%)

The liquid core is very, very small....

Trading days for US corporate bonds
Time since issuance impacts liquidity

0

2

4

6

8

10

12

14

16

18

1 50 99 148 197 246

Avg Daily Trade Count

Days after new issue

Bond count: 1,300

Day 1: 16.8

Day 5: 7.6

Day 20: 4.6

Day 50 : 4.2

16

Newly issued bonds trade largest volume...

Dealer US corp bond trading data, normalized

Source: Citi, 2014-15. Source: TRACE, 1H15-1H16.

...as well as trade count

US corp bonds average trade count post-issuance

Trading volumes and frequency taper 

quickly after issuance

0

10

20

30

40

50

60

70

80

90

100

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Years seasoned (trade date - issue date)

IG normalized volume

HY normalized volume
0

500

1,000

1,500

2,000

 -

 20

 40

 60

 80

 100

 120

 140

 160

<=$250mm $251mm -

500mm

$501mm -

1Bn

$1Bn+

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

 -

 20

 40

 60

 80

 100

 120

 140

 160

 180

<=$250mm $251mm -

500mm

$501mm -

1Bn

$1Bn+

Size of issuance impacts liquidity

17

There are many smaller issues which trade less 

actively than larger issues, especially in IG

US IG – Avg days traded by issue size

excluding matured and 144a, including converts

US HY – Avg days traded by issue size

excluding matured and 144a, including converts

Average

number 

of days 

traded

CUSIP

count

CUSIP

count

Average

number 

of days 

traded

Source: TRACE, Bloomberg FY 2016.
Reciprocally high investor and dealer concentration

18

Half the volume from a few investors...

% total US IG volume of a large dealer

Source: Citi, FY 2017. Source: NAM Greenwich Associates Survey. 

Bouts of illiquidity more likely when activity is 

dominated by few participants with similar strategies

...who themselves use few dealers

Proportion of investor trading by number of dealers, US IG, %

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2017

Top 5 Top 10 Top 20

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0 75 150 225 300 375 450 525

50% Volume

25 Clients

75% Volume

101 Clients

90% Volume

269 Clients
19

Agenda

Credit as a principal market

Liquidity in credit – microstructure

Liquidity in credit – macro themes

Market structure considerations
Building robust electronic markets is a good safeguard

20

Electronic 

Trading

Best 

Practices

Information 

symmetry

Data 

protection, 

separate and 

distinct 

protocols

Technology

Robust testing, 

post-mortems, 

kill switches

Rule books

Enforced 

protocols for 

error trade 

resolution

Compliance 

oversight 

Provisions to 

halt markets, 

identify 

spoofing etc

Governance

Balanced 

market 

representation

Fee structure

Transparent, 

nondiscriminatory 

pricing

SEC Former Chair, Mary Jo White

Commentary to the major equities markets following the Aug 

1 2012 Knight Capital software glitch and the Aug 22 2012 

NASDAQ trade halt

Best practices from more mature electronic markets 

are still largely missing in Credit

The relevant parties in consultation with other market 

participants will:

• Provide comprehensive action plans that address the 

standards necessary to establish highly resilient and robust 

systems for the securities information processors (SIPs), 

including testing standards and disclosure protocols.

• Identify and provide assessments of the robustness and 

resilience of other critical infrastructure systems.

• Provide SIP plan and/or rule amendments addressing the 

issuance, effectiveness, and communication of regulatory 

halts.

• Review their rules relating to the trade break process and 

procedures to reopen trading following a trading halt, and 

provide amendments to those rules as necessary.

• Provide rule amendments to implement “kill switches” that 

would allow exchanges to shut down trading in the event of 

technological failures, and review and consider other 

potential risk mitigation mechanisms.
Standardizing issuance is an unlikely option

21

Would impact only a small number of issuers

0

5

10

15

20

25

0 100 200 300 400

>20 bonds

3 issuers

0

5

10

15

20

25

30

35

40

45

0 100 200 300 400 500 600 700 800 900

>20 bonds

27 issuers

Most issuers have only a few bonds...

Number of bonds outstanding by issuer, $ and € IG

Source: Markit, 2015.

• Large towers can cause significant 

refinancing and credit risk Maturity management

• Potential OID and premium issues

Reopening bond amid 

fluctuating rates and 

credit markets

• Potential impediment on capital 

raising strategies

Bespoke transactions 

for each issuer

• Hinder cash management 

strategies Standardized coupons

• Could be used by issuers, limiting 

bond reopening Covenant language

• Elevated borrowing costs as a 

result of not reaching the threshold

Infrequent, small 

issuers

• Reopening of bonds could push 

issuers wider

Secondary market 

underperformance

$ Credit

(940 issuers)

€ Credit

(439 issuers)

...and cherish their flexibility

Considerations upon issuance consolidation
Transparency is helpful but also introduces new complexities

22

Data quality

Recalibration of 

transparency and 

liquidity thresholds

“Big bang” 

implementation

Global 

harmonization

MiFID II

“One size fits all” 

approach

Impact on less 

liquid blocks

Timing of 

reporting 

conventions

Embedded 

e-trading fees

TRACE

Transparency does not automatically beget liquidity; 

each framework has advantages and challenges
Protocols best left to evolve organically as suited to market

Illiquid/Non-standardized

Liquid/Standardized

Smaller notional Larger notional

Negotiated

trading

Firm

trading

23

Imprudent to prescribe protocols; 

better to remove barriers to confidence 

Central limit 

order book 

(CLOB)

Sessions/

auction

Streamed

quotes

Indication of 

interest (IOI)

Inventory 

posting

Request for 

quote (RFQ)

On-the-run indices

New issue bonds

Large cap investment 

grade bonds

Most active singleName CDS

CDS options

Less active singlename CDS

Off-the-run indices

Non-5y CDS

CDS tranches

HY/distressed bonds

Bespoke correlation
Conclusion

24

Credit remains a 

predominantly 

principal market

Prudent to focus on 

building robust 

infrastructure

A myriad of influences 

have led to a loss of 

heterogeneity

Best 

practices

Inform

ation 

symm

etry

Techn

ology

Rule 

books

Compl

iance 

oversi

ght 

Gover

nance

Fee 

struct

ure

Equities

Credit
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26
Disclaimer (cont’d)

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a greater degree of risk than an investment in other diversified fund types.

Exchange Traded Notes (ETNs): ETNs are not funds and are not registered under the Investment Company Act of 1940. ETNs are not secured debt and do not provide principal protection 

unless stated specifically in the prospectus. The repayment of the principal, interest (if any), and the payment of any returns at maturity or upon redemption are dependent on that issuer’s ability 

to pay. Risks of investing in ETNs include limited portfolio diversification, trade price fluctuations, uncertain principal repayment, and illiquidity. ETNs may have call features that allow the issuer 

to call the ETN at the issuer’s discretion due to the occurrence of certain market events. A call right by an issuer may adversely affect the value of the notes. Investing in ETNs is not equivalent 

to investing directly in an index or in any particular index components. The investor fee will reduce the amount of your return at maturity or on redemption, and as a result you may receive less 

than the principal amount of your investment at maturity or upon redemption of your ETN even if the level of the relevant index has increased or decreased (as may be applicable to the particular 

series of ETNs). An investment in ETNs may not be suitable for all investors. Commissions may apply and there are tax consequences in the event of sale, redemption or maturity of Securities. 

Investors should refer to the ETN’s prospectus to obtain a complete discussion of the risks involved when investing.

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