Credit Research

8 June 2016

Behavior Modification

• Realized bid-offer is a metric some commentators have cited as evidence that 

corporate bond liquidity has not worsened. We use TRACE data to estimate the 

round-trip transaction cost on block trades in investment grade bonds. Realized 

transaction costs decreased about 10% between 2010 and 2015, in line with 

other research indicating that realized bid-offer has not increased through the 

period of supposedly declining liquidity.

• However, aggregate statistics combine trades in on- and off-the-run issues, as 

well as principal and agent trades. The bid-offer charged depends on the type of 

trade, and breaking down the aggregate statistics into the component parts tells 

a more complete story of how liquidity has evolved.

• The average bid/ask spread for agent and principal trades and across different 

vintage buckets has remained largely unchanged between 2010 and 2015. The 

decrease in realized transaction costs can be explained by a change in trading 

behavior to favor lower transaction cost trades. 

• Trading volumes have become increasingly concentrated in recently issued 

bonds. The number of block trades per bond has increased for recent vintage 

securities, while it has declined for older vintage bonds.

• Agent trades have increased significantly, indicating that a much higher proportion 

of trading now happens on order. Block trades with an almost immediate offset 

(within 15 minutes) have increased almost 50% since 2010. On the other hand, the 

fraction of block trades without an offset in five days – one where the risk stays on 

dealer inventories for a longer time – has declined significantly.

• Trades involving highly liquid securities, as well as those done on order, carry the 

lowest bid/ask spread; therefore, concentration of volumes in these trades has 

resulted in lower realized transaction costs. While realized transaction costs are 

lower now, we do not believe that they imply liquidity is better. The change in 

trading behavior comes with other less measurable but equally important costs. 

The time between the desire to trade and execution is likely much higher today. 

Limiting trading to more newly issued securities (to minimize transaction costs) 

lowers portfolio flexibility and could lead to higher tracking error. 

• Finally, our analysis captures only trades that were executed. There have likely 

been many instances when an investor wanted to trade but decided against it,

given the prohibitively expensive bid/ask or dealers’ inability to offer liquidity. 

The material shift in trading behavior is itself evidence that liquidity conditions 

have worsened, in our view.

Jeffrey Meli

+1 212 412 2127

jeff.meli@barclays.com

BCI, US

Shobhit Gupta

+1 212 412 2056

shobhit.gupta@barclays.com

BCI, US

www.barclays.com

This document is intended for institutional investors and is not subject to all of the 

independence and disclosure standards applicable to debt research reports prepared for 

retail investors under U.S. FINRA Rule 2242. Barclays trades the securities covered in 

this report for its own account and on a discretionary basis on behalf of certain clients. 

Such trading interests may be contrary to the recommendations offered in this report.

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 6
Barclays | Behavior Modification

Has liquidity actually deteriorated?

There has been an ongoing debate about the state of secondary market liquidity in the 

corporate bond market. While the deterioration in liquidity post-crisis has been a constant 

talking point for market participants, it remains difficult to characterize, and no individual 

statistic provides conclusive evidence of the amount of liquidity available. Some of the most 

commonly used metrics provide a mixed picture. For example, trading volumes are higher 

over the past few years, although turnover is meaningfully lower (Figure 1), as are average 

trade sizes. Lower turnover could be a sign of reduced liquidity. However, it can also be 

argued that lower turnover and smaller trade sizes are manifestations of change in the 

structure of the market. With fewer leveraged investors such as hedge funds and dealer 

prop desks, reduced volumes are to be expected, regardless of a change in underlying 

liquidity conditions. Smaller trade sizes could be the result of efficient electronic trading 

platforms facilitating more odd-lot trading. 

As we have previously written, a more detailed analysis of the turnover data does indicate 

that liquidity has deteriorated. Turnover has not declined uniformly across the market, as 

would be expected if lower demand for trading were the cause. Instead, trading volumes 

have become concentrated in recently issues bonds (for instance, see A Road Block: 

Liquidity Trends in Investment Grade Corporate Bonds).

Realized bid-offer is a metric some commentators have cited as evidence that corporate 

bond liquidity has not worsened. To examine how realized bid-offer has evolved over time, 

we use TRACE data to estimate the round-trip transaction cost paid by clients in the 

investment grade market. Smaller trades, mostly executed on electronic platforms, 

potentially add noise to our analysis; as a result, we focus only on block trades1 (trade size 

more than $5mn). For every block trade between a dealer and a client, we attempt to 

identify an offsetting (ie, same bond, opposite direction) block trade. The roundtrip 

transaction cost incurred by investors is estimated as the difference in execution level for 

the two trades.2

We consider only trades with offsetting transactions over a five-day period – in other words, 

where we can track the bonds onto and then off of aggregate dealer balance sheets. There are 

trades for which we cannot identify an offsetting trade. This may be because dealers owned 

1 Given the actual notional information is masked for recent block trades, our analysis inherently assumes that all 

block trades have an equal notional.

2 The methodology obviously captures any move in valuations between the execution of the two trades, although 

these moves should be averaged out over thousands of such pairs to provide an unbiased estimate of transaction cost.

FIGURE 1

Investment grade volume and turnover

FIGURE 2

Investment grade volume statistics

2010 2015

Total Volume ($bn) $ 2,280 $ 2,827

Turnover 97% 72%

% of volume in block trades 34% 39%

Avg block trades/bond 16.8 17.1

Transaction Cost

Realized bid/ask on block trades 3.25bp 2.85bp

Average Corporate OAS 170bp 147bp

Note: 2016 stats based on Q1 data. Source: MarketAxess, Barclays Research Source: Barclays Research

60%

70%

80%

90%

100%

110%

120%

130%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

'05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

$trn

Amt Out Volume Turnover

8 June 2016 2
Barclays | Behavior Modification

the risk for an extended time. More likely, this is the result of some leakage in the TRACE data. 

For example, some trades with international clients may be captured by dealer to affiliate 

trades, which we do not include in our analysis (Going with the Flow, April 15, 2016). 

Using the above methodology, we find that realized transaction costs did indeed decline 

between 2010 and 2015. The realized bid/ask for block trades decreased more than 10%,

from 3.25bp to 2.85bp, in that time (Figure 2). This is directionally similar to other results 

indicating that realized bid-offer has not increased through the period of supposedly 

declining liquidity.

3 In the following sections, we examine the data more closely to see what 

has driven transaction costs lower and how much insight about liquidity can be drawn from 

these results.

Trading behavior has changed

The aggregate statistics include realized bid-offer spreads on a large variety of trades. They 

comingle trades on small, off-the-run issues with trades on larger, recently issued bonds. 

Further, they comingle trades done “on order”, meaning that a dealer has both sides of the 

trade lined up in advance of execution, with trades done on risk, meaning that the risk sits on 

dealer balance sheets. The bid-offer charged depends on the type of trade, and we believe that 

breaking down the aggregate statistics into the component parts tells a more complete story 

of how liquidity has evolved and how investors have responded to the new environment. 

First, volumes have become increasingly concentrated: bonds issued in the past year 

accounted for 41% of block trades in 2015, compared with only 34% in 2010 (Figure 3). 

Indeed, the number of block trades per bond has increased for recent vintage securities 

(those issued in the past one year) while it has declined for older vintage bonds (Figure 4).

Further, the combination of higher capital requirements and limitations on dealer inventory 

imposed by the Volcker rule has meant that a higher fraction of trades is now done on “order,” 

where the market maker acts as an agent, rather than a principal. We quantify this by breaking 

down the data into three categories by timing of execution of the offsetting block trade: 

• Within 15 minutes

• 15 minutes to one day

• One to five days

3 Has U.S. Corporate Bond Market Liquidity Deteriorated?, October 5, 2015, Liberty Street Economics.

FIGURE 3

Breakdown of block trades by time since issuance

FIGURE 4

Average block trades per bond

Source: TRACE, Barclays Research Source: TRACE, Barclays Research

0%

10%

20%

30%

40%

50%

60%

<1y 1-5y >5y

Time since issuance

2010 2015

0

10

20

30

40

50

60

<1y 1-5y >5y

Time since issuance

2010 2015

8 June 2016 3
Barclays | Behavior Modification

The first bucket captures “order” trades where the dealer has most likely pre-identified the 

counterparty on the other side of the trade and just acts as an agent to transfer risk from one 

investor to another. The second bucket is likely a combination of order trades and those where 

the dealer has a strong sense of where to find the other side, or the bonds are so liquid that 

the risk is easy to move. The third bucket likely contains trades done on dealer balance sheets, 

without an obvious offset at the time of execution. Finally, trades without an offset in five days 

represent those where the dealer owns the risk for a longer time (or where the other side of 

the trade is lost due to leakage in the TRACE reporting system).

There has been a meaningful shift in the composition of agent versus principal trades since 

2010, with a clear shift toward the former. While about 16% of block trades had an almost 

immediate (within 15 minutes) offsetting transaction in 2010, those trades comprised 23% 

of total block trades in 2015 (Figure 5), an increase of almost 50%. Similarly, the fraction of 

trades with an offsetting transaction between 15 minutes and one day has also increased,

likely also representing some increase in order taking. On the other hand, the fraction of 

block trades without an offset in five days – ie, the risk stays on dealer inventories for a 

longer time – has declined significantly, from 47% to 36%. 

The increase in agent trades is particularly evident in older vintage bonds. Figure 6 compares 

the fraction of total block trades with a 15 minute offset by the vintage of the security. In 

general, a higher proportion of block trades in older securities happen on order; in 2015, 28% 

of block trades in bonds issued more than five years ago had an offsetting trade within 15 

minutes. More important, while agent trades have generally become more prevalent across all 

bonds since 2010, the effect has been clearly more apparent in bonds issued more than a year 

ago, suggesting a shift toward more agency trades for less liquid bonds.

Bid/ask spread: Lower for agent trades but mostly unchanged since 2010 

The offsetting block pair trades allow us to estimate the realized transaction costs for 

different types of transactions. Figure 7 shows the realized bid/ask spread in 2015 for block 

trades categorized by time since issuance:

• Bid/ask costs are lower for trades with an immediate offset, which makes sense since 

dealers take minimal risk in such transactions (acting as agents).

• Transaction cost is higher for older vintage securities, given their lower liquidity. 

However, for pure agent trades, the difference in transaction costs between recently 

issued bonds and those issued more than five years ago is relatively small (only 1.5bp). 

FIGURE 5

Block trades by time of offsetting trades

FIGURE 6

Fraction of block trades with an offsetting trade in 15min

Source: TRACE, Barclays Research Source: TRACE, Barclays Research

16% 23%

15%

19%

22%

22%

47%

36%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2010 2015

<15m 15m-1d 1-5d No offset in 5 days

10%

15%

20%

25%

30%

<0.25y

0.25-0.5y

0.5-1y

1-2y2-3y3-4y4-5y

>5y

Time since issuance

2010 2015

8 June 2016 4
Barclays | Behavior Modification

Because dealers act as intermediaries for such trades, the liquidity risk of the underlying 

security is less important, and we believe the higher bid/ask is partly compensation for 

the increased effort in finding the offsetting counterparty for an illiquid bond. 

FIGURE 7

2015 realized bid/ask spread (bp)

Source: TRACE, Barclays Research

• Not surprisingly, bid/offer costs are higher for block trades where the offsetting trade 

occurs in 1-5 days. Further, the difference in cost is much higher across vintages: the 

realized bid/ask cost is 4bp higher for bonds issued five years ago than for recently 

issued securities. Given that the inventory sits on dealers’ balance sheet for a slightly 

longer time (1-5 days), the liquidity premium charged by dealers is higher.

The realized transaction costs for agent and principal trades and across different vintage 

buckets have remained largely unchanged between 2010 and 2015 (Figures 8 and 9).

So why are realized transaction costs lower?

With the bid/ask spread in different bond vintage buckets remaining largely unchanged 

since 2010, the decrease in realized transaction costs (Figure 2) can be explained by a 

change in trading behavior to favor lower transaction cost trades. More trading is 

0

1

2

3

4

5

6

7

<0.25y

0.25-0.5y

0.5-1y

1-2y2-3y3-4y4-5y

>5y

Time since issuance

<15m 1-5d

FIGURE 8

Realized bid/ask for block trades with an offsetting trade in 

15 minutes (bp)

FIGURE 9

Realized bid/ask for block trades with an offsetting trade in 

1-5 days (bp)

Source: TRACE, Barclays Research Source: TRACE, Barclays Research

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

<0.25y

0.25-0.5y

0.5-1y

1-2y2-3y3-4y4-5y

>5y

Time since issuance

2015 2010

0

1

2

3

4

5

6

7

8

<0.25y

0.25-0.5y

0.5-1y

1-2y2-3y3-4y4-5y

>5y

Time since issuance

2015 2010

8 June 2016 5
Barclays | Behavior Modification

concentrated in highly liquid securities and/or done on order, both of which carry lower 

bid/ask costs. Figure 10 shows the change in block trading volume between 2010 and 2015 

by execution time and bond vintage. 

• Agent trades in newly issued bonds – which are the least expensive to execute (average 

bid/ask 1.1bp) – comprised only 4.8% of all block trades in 2010, but in 2015 accounted 

for 8.2% of total block trades. Agent trades in bonds issued 1-5 years ago have also 

increased meaningfully.

• On the other hand, trades with an offsetting transaction in 1-5 days in older vintage 

bonds – the most expensive with an average bid/ask of 5-6bp – have declined the most 

since 2010.

The catalyst for change in trading behavior has likely come from both the dealer and 

investor communities. Higher cost of capital and restrictions imposed by the Volcker rule 

have impaired dealers’ ability to provide balance sheet to corporate bond trading,

mandating a move to more agent trading/focusing on more liquid bonds. At the same time, 

clients’ desire to minimize bid/ask costs, particularly given the rather steep penalty for 

principal trades/illiquid bonds, has had the same effect.

While realized transaction costs are lower now, we do not believe that they imply that liquidity 

is better. Investors may be incurring lower bid/ask costs, but the change in trading behavior 

does come with other less measurable but equally important costs. Waiting for a dealer to find 

the offsetting counterparty for any trade means that the time between the desire to trade and 

execution is much higher today. At the same time, limiting trading to more newly issued 

securities (to minimize transaction costs) limits portfolio flexibility and could lead to higher 

tracking error. 

Further, our analysis captures only trades that were actually executed. In fact, there have 

likely been many instances when an investor wanted to trade a bond but decided against it,

given the prohibitively expensive bid/ask or dealers’ inability to offer liquidity. The fact that 

the two factors combined were severe enough to alter the trading behavior of market 

participants is perhaps the strongest evidence that liquidity conditions have deteriorated. 

The shift has somewhat ironically meant that more volumes are now concentrated in the 

least expensive trades (in terms of transaction cost), which has caused realized bid/ask 

costs to decline. In our view, lower transaction costs are more an outcome of a tougher 

trading environment than evidence that liquidity conditions are improving.

FIGURE 10

Change in block trading volume since 2010

The number in each box refers to the change in block trading volume between 2010 and 2015 in that bucket. Green 

shading shows buckets with the highest increase, while red shading shows those with the most decrease. 

Source: TRACE, Barclays Research

8 June 2016 6
Analyst Certification

We, Shobhit Gupta and Jeffrey Meli, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all 

of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to 

the specific recommendations or views expressed in this research report.

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