■ At first blush, it may appear as though the fixed income market is less liquid than 

it has been in the past. Corporate bond markets have grown considerably over the 

last several years, just as dealers’ appetite to hold bonds in inventory to facilitate 

trades has diminished. 

■ This shift in dynamics, though undeniable, is not a harbinger of doom, nor is it the end 

of the story. Rather, it’s the beginning of a new chapter that highlights the resiliency of 

the financial markets and the imagination of many of its participants. The market and its 

participants are doing what they always do—adapting, innovating, and evolving. 

■ The markets have absorbed the changes spurred by the latest “new normal” by taking 

advantage of technological advancements and devising new methods of matching buyers 

and sellers. Maybe most important, the transformation of the fixed income landscape 

has not had the deleterious impact that some had predicted (or are still predicting). 

■ We believe that these changes born of regulatory reform and monetary policy—including 

electronic trading and increased competition—will stick. And we conclude that there 

is even more we can do to capitalize on the developments that have already taken hold.

The buck stops here: 

Vanguard money market funds

Vanguard commentary October 2016

Innovation and evolution 

in the fixed income market
Introduction

Vanguard believes that several key improvements will 

help electronic trading continue to evolve in ways that 

are most beneficial to investors. We strongly advocate 

for policies and practices that (1) limit the fragmentation 

of trading, (2) encourage direct interaction between buyers 

and sellers, (3) better link trading and order-management 

systems, (4) provide greater price transparency, and (5) 

protect against information leakage. 

Our stance is supported by the following points, which 

we’ll cover in more depth throughout this paper. 

• The largest dealers have significantly reduced their 

bond inventories and the resources dedicated to bond 

trading. But despite constraints—both market-driven 

and self-inflicted—dealers continue to make markets, 

and participants can trade large volumes of bonds at 

market prices. 

• Electronic trading has become increasingly important 

in fixed income markets, enabling greater use of 

automated, computer-driven trading based on 

algorithms. This has allowed a more diverse set 

of participants to enter the market, introducing new 

sources of liquidity, increasing competition, and reducing 

transaction costs. Although some fear that removing 

the human element from trading is a cause for concern, 

at Vanguard we do not believe that electronic trading 

increases market risk or impairs liquidity.

• Innovation in open-ended investment vehicles has 

generally boosted market liquidity because two of 

these vehicles (exchange-traded funds and target asset 

allocation funds) have provided stabilizing effects.

Finally, we offer our perspective on ways that 

technological advancements can help our industry 

continue to grow, and we expand on our simple 

blueprint for encouraging these developments. 

All told, our examination shows that the potential for 

significant market disruption or systemic risk caused 

by a perceived reduction in liquidity is minimal. Prudent 

mutual fund regulation, the structure of funds, and the 

effective use of liquidity risk management tools by 

portfolio managers help ensure that liquidity risk—which 

comes with the territory in investment management—

will not spill over to the broader financial markets in a 

systemic manner. We believe the mutual fund industry 

will continue to serve investors as effectively as ever.

A healthy dose of perspective

In our January 2016 paper, “Clear Perspectives on Bond 

Market Liquidity,” we provided an in-depth examination 

of the hypothesis that lower bond market liquidity portends 

a crisis for the financial markets. We found that this is 

simply not the case. 

Among our findings: 

• Liquidity is dynamic. The ability to convert an asset 

to cash in a reasonable amount of time and in a 

prudent manner changes constantly. It responds 

to shifts in investor preferences, dealer financing 

costs, profit opportunities, and a myriad of other 

factors that influence capital market activity. The 

cost of liquidity for a particular asset type, defined 

as the size of the asset’s bid-ask spread (see 

Glossary), also varies based on a number of elements; 

it is not a binary measure.

2

Notes about risk and performance data: All investing is subject to risk, including the possible loss of the money you 

invest. Investments in bond funds are subject to interest rate, credit, and inflation risk. Investments in securities issued 

by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially 

high in emerging markets. While U.S. Treasury or government agency securities provide substantial protection against 

credit risk, they do not protect investors against price changes due to changing interest rates. There is no guarantee that 

any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of 

income. Diversification does not ensure a profit or protect against a loss. 
1 Source: A Six-Part Series on Bond Market Liquidity (Federal Reserve Bank of New York, October 2015).

• Mutual funds, charged with helping shareholders 

diversify their portfolios across hundreds or thousands 

of securities and providing access to their money when 

needed, still make up only a small fraction of bond 

market capitalization. The belief that millions of 

“unsophisticated” investors would leave the market 

when trouble arose and trigger a liquidity crisis has 

proven unfounded. Time and again, mutual fund 

investors have not redeemed in significant numbers, 

even during the darkest days of the 2008 financial 

crisis. They didn’t broadly scramble for the exits in the 

aftermath of the U.K. “Brexit” vote in June 2016. Nor 

did they leave during December 2015’s volatility spike 

in the high-yield market that helped contribute to the 

liquidation of one mutual fund. 

• There is no conclusive evidence that declines in 

inventory and turnover have had a negative effect 

on the liquidity metrics that matter most in bond 

fund management. In fact, bid-ask spreads on 

corporate bonds are narrower today than they 

were when dealer inventories were at all-time 

highs during the financial crisis. And the Federal 

Reserve has found1 that a corporate bond trade 

now has a smaller estimated impact on a bond’s 

market price than it did in the years before the crisis. 

So, why all the hand-wringing? 

Despite the evidence presented in our January 2016 

paper, concerns about liquidity persist in some quarters. 

This is an understandable reaction because some elements 

of fixed income trading have undergone significant shifts. 

• The value of corporate bond inventory held by dealers 

globally has fallen considerably from its 2008 peak. 

The size of market-making desks has also shrunk in 

an effort to reduce costs as firms no longer need the 

coverage required prior to the global financial crisis. 

• New regulations have changed the way that banks 

and other broker-dealers are capitalized and how 

they operate. The banking system is stronger and 

the financial system is less susceptible to the risks 

of leverage that precipitated the crisis. However, 

one of the trade-offs is that market making is more 

expensive for banks. As a result, they are less willing 

to take on the risk. 

• Bond market volatility has dropped in response to 

the extremely low interest rate environment. Naturally, 

dealers are less prone to offer market making when 

the cost of liquidity has decreased or when profitability 

drops because of increased efficiency, lower volatility, 

or other factors. 

Nonetheless, dealers continue to make markets in fixed 

income securities, and participants continue to execute 

trades at market prices. There is evidence that average 

trade size has shrunk, offset by an increase in the number 

of trades, but this was not unexpected. In fact, a similar 

effect was seen several years ago as equity markets 

moved to more electronic execution. 

Overall trade volume has not declined (see Figure 1), and 

bid-ask spreads are narrower today than before the crisis, 

indicating ample liquidity in the corporate bond market 

(Federal Reserve Bank of New York, October 2015). 

With any security, brokers quote two prices: a bid (the 

highest price a prospective buyer is willing to pay) and an 

ask (the lowest acceptable price for a prospective seller). 

The smaller the difference between the two, the more 

easily—and cheaply—a security trades.

3

Figure 1. Growth in U.S. investment-grade 

bond trading

Notes: Growth is measured by the increase in average daily trading volume for 

each calendar year. Electronic growth is represented by MarketAxess U.S. highgrade trade volume data. Total growth is represented by U.S. high-grade trade 

volume as reported by FINRA Trade Reporting and Compliance Engine (TRACE). 

Consistent with FINRA TRACE reporting standards, both sides of trades are included 

in a company’s reported volumes when the company executes trades on a riskless 

principal basis between two counterparties. 

Sources: MarketAxess, FINRA TRACE. Annual growth rate

0 

5 

10 

15 

20 

25% 

2012 2013 2014 2015 

Electronic

Total
Technology is driving innovation 

It should come as no surprise that retrenchment by 

traditional dealers has created opportunities for innovators 

to find more efficient ways to match buyers and sellers. 

And, of course, technology is at the center of this 

movement. At the same time that traditional dealers 

are struggling with their new world order, technological 

changes have helped lower the barriers to entry, making 

way for new—and very efficient—liquidity providers. 

It’s important to understand that electronic trading 

and automated trading are not synonymous. Electronic 

trading is the transfer of ownership of a security 

whereby the buyer and seller negotiate and/or execute 

the trade through systems such as electronic quote 

requests and communication networks. In automated 

trading, orders are placed—and decisions are made—

online autonomously. 

Electronic trading systems take several forms: 

• Request for quote (RFQ). This is a common trading 

protocol in which users request prices from platform 

market makers on an order of a specific size. (The 

identity of the participants may or may not be disclosed, 

depending on the platform.) In most fixed income RFQ 

systems, the requests are sent only to dealers, and 

only in limited numbers. These systems, which are 

not necessarily built for speed, are generally used in 

markets characterized by a greater number and variety 

of securities, such as corporate bonds and off-the-run 

U.S. Treasuries. They may also be used in markets 

where participants lack the scale of large dealers.

Tradeweb is an example of an RFQ system. 

• Central limit order book (CLOB). With this trading 

protocol, active bids and offers are stored and 

then executed in priority order. Typically, quotes 

are transparent to participants in the interdealer 

market on a pre-trade basis. Used most often for 

strategies that depend upon speed, CLOB systems 

typically trade highly liquid securities, such as U.S. 

Treasuries. Examples are BrokerTec and eSpeed. 

• All-to-all. This protocol, which represents a small 

but growing channel of electronic bond trading, 

allows buyers and sellers to interact directly with 

one another, providing a high level of transparency. 

This is an important distinction because most electronic 

trading platforms match dealers to dealers and to 

clients. Because so-called end clients are participating 

equally—and directly—with each other, costs are 

low and liquidity is highly accessible. For example, 

MarketAxess offers an all-to-all trading protocol.

4

Electronic trading in capital markets: Key events

1971 First electronic stock market (NASDAQ) introduced.

1970s–

1990s Electronic stock markets established globally.

1989 Foreign-exchange electronic trading begins.

1990s Growth of electronic communication networks 

(ECNs) allows market makers to trade anonymously.

1994 Equity futures and options markets move 

to electronic trading.

1998 United States adopts alternative trading system rules 

to structure ECNs.

1999 Electronic trading of U.S. Treasuries 

and European government bonds begins.

2000s More powerful computers and development 

of algorithms enable high-frequency trading.

2005 NASDAQ and FINRA begin full dissemination of 

transaction and price data for all U.S. corporate bonds.

2007

As a result of Regulation National Market System (NMS), 

U.S. securities industry updates its trading model to facilitate 

automated trading and immediate price discovery.

2009–

2012

Standardization of credit default swap (CDS) contracts 

enables electronic processing and centralized clearing 

of CDS trades.

2009–

2016

Fixed income ETFs undergo further development 

and increased growth.

2009–

2016

Electronic platforms to facilitate bond trading 

experience global growth.

1971

1970s–

1990s

1989

1990s

1994

1998

1999

2000s

2005

2007

2009–

2012

2009–

2016

2009–

2016

Source: Vanguard.
5

What types of securities trade 

through these systems?

As you might expect, each electronic platform is not 

suitable for all types of securities, and all types of securities 

are not suitable for each platform because of the high 

degree of fragmentation in the bond market. A single issuer, 

for example, often makes multiple issuances that are not 

interchangeable. Electronic trading is more advanced in 

the largest, deepest, and more standardized markets that 

include many different types of participants and where 

secondary-market trading is conducted primarily among 

dealers. Here’s a brief overview of what’s traded where. 

Government and agency cash bonds 

and fixed income futures

Electronic platforms that facilitate the trading of highly 

liquid sovereign bonds in the interdealer market have 

existed for some time in many developed and emerging 

markets. Automated trading in these securities has 

increased over the past several years (see Figure 2). 

A decade ago, banks and investment banks dominated 

U.S. Treasury trading. Over the past decade, however, 

these trades have largely moved to electronic platforms. 

In the interdealer cash market and the futures market, 

high-frequency algorithmic traders provide additional 

liquidity by facilitating more than half of all Treasury trading.

In the client-to-dealer cash market, trading is not fully 

electronic. It’s conducted primarily through RFQ 

systems, where dealers who receive a client request 

work the trade as an agent. In some cases, dealers 

may automatically match requests and offers. Trading 

does not take place through CLOB systems. 

In the Treasury futures market, trading is more electronic 

because by law it must be conducted on a registered 

exchange (in practice, primarily the Chicago Mercantile 

Exchange). Today, approximately 90% of all Treasury 

futures trading that takes place on an exchange is 

conducted electronically.2 Nonbank participants account 

for the largest share. 

Corporate cash bonds

Electronic trading is less common in corporate bond 

markets because of the large number of securities issued. 

As there are often many “flavors”—same issuer, different 

issues—of the same bond, these securities trade less 

frequently. (In contrast, when it comes to equities, 

companies typically issue a single class of stock.) 

However, the rise of electronic trading has coincided 

with a decrease in average trade size and an increase 

in trade frequency. This trend is likely to continue, given 

the structural changes described earlier. 

In 2015, nearly 80% of investment-grade bond market 

participants used electronic platforms for at least 

some trading functions—up from 58% in 2010.3 For 

the purposes of this study, “usage” included seeking 

quotes, posting quotes, or conducting trades. 

In 2015, about 14% (or roughly $575 billion) of all U.S. 

investment-grade corporate bond trades took place on 

the MarketAxess trading platform, up 78% from 2011.4

Figure 2. Electronic trading activity of government 

bonds in Europe

Notes: Figure shows the proportion of government bond investors based in Europe 

trading global government bonds electronically. Data are based on responses from 

510 government bond investors in Europe in 2008, 352 in 2009, 400 in 2010, 372 

in 2011, 385 in 2012, 416 in 2013, 405 in 2014, and 400 in 2015. 

Source: Greenwich Associates 2015 European Fixed-Income Investor Study.

80% 

60

40

20

0

2008 2009 2010 2011 2012 2013 2015

Portion of investors trading electronically

Portion of volume traded electronically

63% 

73% 71% 70% 69% 

74% 77% 80% 

43% 43% 44% 

39% 

47% 41% 

57% 58% 

2014 

2 Source: Bank for International Settlements, Electronic Trading in Fixed Income Markets, January 2016.

3 Source: Greenwich Associates, The Continuing Corporate Bond Evolution, December, 2015.

4 Source: MarketAxess, “2015 Highlights,” Trade On, 2016. 
5 “Click or Call? Auction Versus Search in Over-the-Counter Market,” Journal of Finance, 2015.

6 “The U.S. Treasury Market,” Joint Staff Report, U.S. Department of the Treasury, July 2015.

All-to-all systems have seen tremendous growth in 

Europe. MarketAxess reports that its fixed income trading 

platform booked record volumes in the first three months 

of 2016. The company’s global clients traded $944 million 

of European fixed income products through its all-to-all 

system in the first quarter, up 140% from the previous 

quarter. Across European and U.S. securities, European 

clients traded $4.8 billion in the first quarter of 2016, up 

73% from fourth-quarter 2015.

Electronic trading provides many advantages to investors, 

including the following:

• Broader market access. The buy side—primarily 

investing institutions such as mutual fund providers, 

pension funds, and insurance companies—can 

participate directly (or via a designated dealer) to find 

a buyer or a seller. This broader level of access can 

bring together a disparate group of investors and 

traders who have varying interests and objectives, 

increasing the likelihood of a match. 

• Continuous access. Increased connections 

between market participants—across platforms—

provides real-time access to a broad group of liquidity 

providers and suppliers. 

• Greater transparency. Price dispersion is reduced, 

price discovery is more rapid, and analysis of best 

execution and trading costs is more efficient. 

• Reduced costs. The reductions have come in both 

direct costs such as trading (particularly for smaller 

trades) and indirect costs such as search. To be fair, 

electronic trading does not guarantee the lowest cost 

in all instances; a negotiation over the phone can yield 

a better one. However, researchers have found that it 

can reduce transaction costs, particularly for smaller 

trades and for bonds with certain characteristics such 

as higher credit quality and larger issue size.5 Search 

costs include the time and resources associated with 

identifying a counterparty. 

• Increased efficiency. Electronic trading platforms 

facilitate straight-through processing and settlement 

of trades. 

6

A real-life stress test for new liquidity providers

What happens when theory collides with reality? 

October 15, 2014, was one of the most volatile days in 

the history of the bond markets. On that day, nonbank 

participants accounted for the largest share of market 

making. Principal trading firms (PTFs) accounted for more 

than 50% of the total trading volume across various bond 

maturities in both cash and futures markets. Traditional 

bank dealers accounted for 30% to 40% of volume in 

the cash market but less than 20% of the futures market. 

At the height of the volatility (between 9:30 a.m. and 9:45 

a.m., Eastern Standard Time), trading activity among PTFs 

increased sharply (to about 75% of the cash market and 

about 68% of the futures market). At the same time, 

the share of bank-dealer trading activity declined 

(to about 21% of the cash market and 14% of the 

futures market). 

These trading figures are consistent with the proportion 

of PTF trading volume in recent history and are not an 

anomaly for an unusually volatile day.6 

Nonbank participants also maintained tighter bid-ask 

spreads than bank dealers did in both the cash and 

futures markets throughout the day. 

This example illustrates the beneficial impact of PTFs 

during an extremely volatile period. 
Who’s doing the trading? 

As noted earlier, the movement toward electronic trading 

has resulted in the emergence of a more diverse set of 

market participants, increasing competition and providing 

new sources of liquidity. 

Here’s a breakdown. 

• Principal trading firms. For the most part, these 

firms are involved in automated, high-frequency 

trading. They seek profits through the execution 

of a very large number of small trades typically held 

for a very short time (seconds or fractions of a 

second). Very little automated or electronic trading 

qualifies as high-frequency. 

• Buy-side participants. These firms have always been 

a part of the equation, providing liquidity by buying 

and selling bonds without being reliant on dealers to 

take transactions on their balance sheets. Previously, 

traditional bank dealers typically assumed principal risk 

when providing liquidity to the market. Hedge funds, 

for example, have greater investment flexibility such 

as leverage and can employ a longer-term investment 

horizon or an automated high-frequency trading 

strategy. Mutual funds don’t provide liquidity by taking 

assets onto their balance sheets and are severely 

restricted on leverage. However, they may make prices 

that offer liquidity to others, provided the transaction 

is in the best interests of their clients. To be clear, 

buy-side firms have not become market makers. 

Rather, they are participating in the market directly—

as buyers and sellers—more regularly. This is a positive 

development for the markets and for investors. 

• Traditional bank dealers. The most traditional 

of trading entities continue to play a major role. 

They provide liquidity in the secondary market 

when conditions offer what they deem to be an 

appropriate level of profit given the associated risk. 

Liquidity’s behind-the-scenes allies 

Two relatively recent industry innovations—exchangetraded funds (ETFs) and target-date retirement funds— 

have deservedly garnered widespread market acceptance. 

Embedded in the design of these popular offerings are 

characteristics that increase efficiency and can effectively 

serve as market stabilizers. Simply put, structure matters. 

Let’s take a look at each one.

Exchange-traded funds

Because the majority of ETF trading takes place on 

the secondary market (see Figure 3), these investment 

vehicles create an additional source of liquidity for bond 

fund investors. 

7

Figure 3. The majority of bond ETF trading volume is conducted on the secondary market

Notes: Figure shows the percentage of daily bond ETF trading volume conducted solely on the secondary market. The median ratio is 83%, suggesting that for every $1 

in trading volume, only 17 cents results in primary market trading. Put another way, 83% of the trading volume results in no portfolio management impact and no trading 

in underlying securities.

Source: Vanguard calculations, based on daily data from Bloomberg. Secondary market ratio

0.00 

0.10 

0.20 

0.30 

0.40 

0.50 

0.60 

0.70 

0.80 

0.90 

1.00 

January 2012 June 2012 January 2013 June 2013 January 2014 June 2014 January 2015 June 2015 January 2016
In fact, according to data on transaction costs, ETFs have 

indeed contributed to higher liquidity in the fixed income 

markets. For example, as with any security, brokers quote 

two prices: the bid and the ask. The difference between 

the two prices for ETFs is often narrower than it is 

for the fund’s underlying bonds. This is because the ETF 

consolidates many bonds into a standard trading unit, 

thereby concentrating liquidity. The net effect is that a 

narrower spread results in less profit for the broker that 

facilitates the purchase or sale of the ETF but cheaper 

transaction costs for the investor.

Case in point: December 2015 was a time of considerable 

stress in the high-yield credit market. Volatility spiked, 

and the Third Avenue Focused Credit Fund announced 

that it had suspended shareholder redemptions. Many 

participants used ETFs to buy and sell high-yield market 

risk. The result? High-yield bond ETFs traded in very high 

volume at tight bid-ask spreads, providing additional 

liquidity to the market. 

Target-date funds

Target-date funds are unique because of is their simplicity. 

Investors select a fund that most closely aligns with 

their goal—say, retirement. The fund then automatically 

and systematically shifts to a more conservative mix of 

investments (fewer stocks, more bonds) as the target date 

approaches. In the meantime, the investments within the 

fund are continuously rebalanced to ensure that the mix 

doesn’t vary much from its mandate. 

Bringing the fund back into balance requires 

a counterintuitive investment approach, but it is 

a practice that adds liquidity. Practically speaking, 

these contrarian-by-design funds are often buying 

investments that have declined in value and selling 

those that have risen. They are heading in the opposite 

direction of speculative investors, who are busy buying 

winners and selling losers. Target-date funds, therefore, 

can provide stability, particularly when market swings 

are considerable. And because of their meteoric growth 

(see Figure 4), which is expected to continue, the 

positive impact of this stabilization is significant. 

8

Figure 4. Target-date fund asset growth

Source: ICI Quarterly Retirement Market Data, First Quarter 2016. U.S. dollars (billions)

0

200

400

600

800

$1,000 

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 

Notes about risk and performance data: Investments in target-date funds are subject to the risks of their underlying 

funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire 

and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative 

ones based on its target date. An investment in a target-date fund is not guaranteed at any time, including on or after the 

target date. Investors should periodically monitor the portfolio to ensure it is in line with their current situation.
7 Financial Industry Regulatory Authority Rule Filing SR-FINRA-2016-027 proposes to expand TRACE reporting rules to include certain secondary market transactions in marketable 

U.S. Treasury securities. The European Union’s Markets in Financial Instruments Directive (MiFID II) imposes transaction reporting requirements on financial market participants 

for a broader universe of financial instruments, including over-the-counter fixed income securities, among others.

Our suggested blueprint 

We believe that the widespread adoption of five key 

recommendations will bolster an already strong system 

by focusing on several core principles. These are: greater 

transparency, better systems integration, more direct 

interaction between buyers and sellers, and prudent 

controls on the number of trading venues and the 

information available through them. The following 

principles will help ensure that fixed income markets 

across the globe continue to evolve in the best interests 

of shareholders. 

• Limit trading fragmentation. Focusing trading on 

a limited number of electronic venues, or aggregating 

trade information, will help ensure that the diverse 

universe of buyers and sellers will converge and liquidity 

will be concentrated. In addition, reduced fragmentation 

likely will mean lower search costs and more intense 

price competition. 

• Further develop all-to-all networks. As noted 

earlier, these networks allow direct interaction 

between buyers and sellers. For example, asset 

managers can interact directly with dealers 

and other asset managers with whom they may 

not have a direct trading relationship. The result: 

lower costs and additional sources of liquidity. 

Also, these networks enable traditional buy-side 

firms to participate as “price makers” (but not 

market makers) when in the best interest of clients. 

The overall market benefits when buy-side firms 

more regularly participate directly as buyers 

and sellers. 

• Integrate trading and order-management systems. 

Electronic platforms must evolve to better integrate 

trading systems with buy-side order-management 

systems in order to increase efficiencies and reduce 

search costs. For example, the ability to find bonds for 

potential sale or purchase based on their characteristics 

would enable buy-side firms to more easily identify 

substitute securities. 

• Provide greater price transparency. A greater degree 

of pre-trade price transparency on electronic platforms 

is a necessary step in the evolution of fixed income 

markets. Continuous price setting, similar to that 

experienced in the move to electronic trading in equity 

markets, will undoubtedly encourage participation. 

Not insignificantly, pre-trade security price data also 

support compliance with best-execution regulation—

a benefit to both financial services firms and their 

investors. Vanguard is generally supportive of current 

regulatory efforts in the United States and Europe7

to expand post-trade reporting of secondary fixed 

income market transactions because of the benefits 

to investors. 

• Protect against information leakage. Information is 

king, and transparency provides plenty of advantages 

for investors and market participants, but there can 

be too much of a good thing. Platforms must protect 

against unwanted dissemination of information from 

order-management systems. We must ensure that 

negotiations and trading activity are not unintentionally 

or unnecessarily shared. 

Conclusion

There is no denying that the fixed income markets 

have undergone a considerable shift over the past 

several years. 

However, our analysis demonstrates that market 

participants—both traditional players and newer arrivals—

have adapted to the new reality. Trading has become less 

profitable for some, but at the same time doors have 

opened for new ways of linking buyers and sellers and 

maintaining a vibrant marketplace. This real, sustainable 

vibrancy stands in stark contrast to the often-repeated 

narrative that the shift in market dynamics spells trouble 

for the fixed income market and its participants. 

Not surprisingly, advances in technology are at the 

forefront of the adaptation, evolution, and innovation 

that have taken hold. Sharing information, analyzing 

data, finding counterparties—and thus, completing 

orders—now take place in a seamless, timely, and 

efficient manner in high-quality, well-diversified markets. 

The principles outlined above provide a solid framework 

for capitalizing on the advances already made and 

continuing to adapt as the market evolves further, 

as it almost certainly will. 

9
References

Bank for International Settlements. Electronic Trading in Fixed 

Income Markets. January 2016.

Federal Reserve Bank of New York. A Six-Part Series on Bond 

Market Liquidity. October 2015.

Greenwich Associates. The Continuing Corporate Bond Evolution. 

December 2015.

Hendershott, T., 2015. “Click or Call? Auction Versus Search in 

Over-the-Counter Market,” Journal of Finance, 2015.

MarketAxess. “2015 Highlights.” Trade On, 2016.

U.S. Department of the Treasury, “The U.S. Treasury Market,” 

Joint Staff Report, July 2015.

10
Glossary

Algorithm: A series of steps used to solve a problem 

or complete a process. In the trading world, algorithms 

are executed by computers to buy or sell securities 

under certain conditions. High-powered computers can 

instantaneously take into account numerous variables 

(often hundreds or more) spelled out by an algorithm. 

Bid-ask spread: The difference between the price that 

a prospective buyer is willing to pay for a security and 

the price that a seller is willing to accept for that security. 

This difference represents the cost of completing 

the transaction. 

Cash market: A system for immediate settlement 

of securities transactions, either electronically or on 

an exchange. (In contrast, a futures market facilitates 

trades that occur at a specified date.) Cash markets 

typically take two forms: the interdealer market, where 

institutions trade with one another, and the dealer-toclient market, where dealers trade with their customers 

(typically asset managers, insurance companies, and/or 

pension funds). 

Electronic trading: Processing buy and sell orders 

over a communications network that links thousands 

of computers. Electronic trading is sometimes confused 

with high-frequency trading. All high-frequency trading 

is electronic, but not all electronic trading is high-frequency. 

Exchange-traded fund (ETF): A basket of securities 

(stocks, bonds, or commodities) that trades on a stock 

exchange. Unlike mutual funds, which are priced once 

a day, ETFs can be traded throughout the day at prices 

that vary with the market. Though the vast majority of 

ETFs are designed to follow an index of securities, 

actively managed products are also becoming available. 

High-frequency trading: A system that executes large 

numbers of orders extremely quickly. Using sophisticated 

algorithms and computers, the orders are placed based 

on certain market conditions and characteristics. 

Interdealer activity: Trading conducted between 

banks and financial institutions. 

Liquidity: Essentially, the ability to convert an asset 

to cash in a reasonable amount of time and in a 

prudent manner. 

Market making: Maintaining an orderly and efficient 

market by offering to buy and sell securities at publicly 

traded prices. Firms that play this role—by agreeing to 

buy or sell or holding securities to help facilitate others’ 

trades—may be called market makers or specialists. 

Off-the-run: All Treasury bonds and notes issued 

earlier than the most recent batch (of similar maturities). 

Generally, these securities are traded less frequently 

than the most recent issues and therefore tend to be 

less expensive and offer a higher yield. 

Order-management system: A computer-based platform 

for buying and selling securities that allows participants 

to enter and update orders and receive reports on their 

orders’ status. 

Principal trading firm (PTF): A company whose primary 

business is buying and selling securities, typically through 

proprietary automated trading strategies. Many, though 

not all, engage in high-frequency, algorithmic trading. A 

PTF may be registered as a broker or dealer but typically 

does not have clients. 
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