The Modernisation of the European Bond Market: The journey continues

Bond markets have evolved significantly since the global financial crisis in 2008. Post-crisis, regulatory oversight was enhanced, funding and capital costs increased, and operating models were rationalised accordingly.

Additionally, banks started changing their operating models to increase their reliance on electronic trading. Against this backdrop, the use of index, or “basket” instruments, including fixed income Exchange Traded Funds (ETFs) and fixed income index derivatives, has significantly increased.

This increasing number of sophisticated investors incorporating ETFs into their investment framework has necessitated rapid development in the trading ecosystem. Technological advancements associated with the asset class are furthering the modernisation of the European bond market.

Critical to this growth has been the increasing electronification of ETF trading, which has led to further automation, easier access and lower execution costs. More and more brokers are providing automatic quotes on ETFs through request-for-quote platforms, accelerating the execution of small and recurring orders. Banks have also been building out their ETF algorithmic trading capabilities, leading to the possibility of layering ETF execution strategies based on pre-programmed instructions.

Beyond this, MiFID II regulatory requirements pushed companies to begin aggregating secondary trading volumes across listings and trading venues, offering a much clearer picture of total ETF liquidity. The strategy of portfolio trading (in which a counterparty offers a portfolio of multiple line items simultaneously, to be taken all together or not at all, in a single trade) has grown significantly in Europe as technology and pricing capabilities have improved.

The Future of the ETF Ecosystem
Growing adoption of fixed income ETFs and other index and portfolio-based products, coupled with growth in electronic trading, algorithmic pricing capabilities, and dramatic improvements in technology are continuing to revolutionise the way investors access European corporate bond markets.

The COVID-19 selloff in 2020 proved to be a catalyst for further adoption of fixed income ETFs, particularly by institutional investors. Since then, further bond and ETF ecosystem developments in the secondary and primary markets along with the development of better tools and analytics to assess ETFs alongside other instruments are enhancing investors’ ability to use ETFs as part of their toolkit, further accelerating adoption.

The growth in index vehicles is a recognition of the need for liquidity and transparency to increase or decrease exposure when making portfolio construction decisions. Given the still opaque nature of the underlying cash bond market, coupled with the lack of a timely, unified picture of bond trades and pricing (a consolidated tape), we believe ETFs will continue to play an increasingly integral role for investors looking to access and navigate bond markets. Investors who embrace fixed income ETFs and other index exposures may benefit from improved transparency, liquidity and efficiency.

Risk: When interest rates rise, there is usually a decline in the market value of bonds, and the issuer of the bond may not be able to repay and make interest payments

Source: ‘The Modernisation of the of the European bond market: The journey continues’, BlackRock, as of 31/10/2022.