The End of An Era for Odd Lots

odd Lots coming to an end? I'm not no, Okay, this is not the end of the Odd Loots Podcast as we know it. It is, however, I'm relieved. Yes, it's good for both of us. It is, however, the episode in which we just gus the possible end of odd Lots trading as we know it. Yeah. So this is something we've never really talked about, I don't think, which is where our name of the podcast comes from. I'm not sure if we've ever even really approached that, have we No? I think we just sort of threw

it out there and started recording. But for those people that don't know, odd thoughts, it's basically a term that describes a order for stocks or bonds of an unusual size. Basically often it's it's small orders of bonds or stocks. So it's like, if you were to place an order for I don't know, seven shares of a company or something like that, something weird, that's not the normal increment, that would be an odd lot, something irregular. Yeah, exactly.

And from what I remember, we chose the name, well, we're looking for something catchy, and I thought Odd Thoughts also sort of described the ethos of the podcast in the sense that we cover a lot of slightly random ground sometimes right stories that don't typically quite fit perfectly into the overall market themes. Because of course, stories that fit uh nicely into the overall market stories are covered

in pretty uh pretty nice depth anywhere. I'm thinking, you know, back to our old days of like studying the talking about the cattle market, for example. You know, it doesn't quite a fit into the typical markets reporting. No, there's not enough cattle market coverage, that's for sure. Fish bubble, that's right. But the reason we are actually finally talking about Oddoughts themselves is because there's been a little bit

of news on this front. A few weeks ago Bloomberg actually reported that I think it was JP Morgan and City Group were shutting down their odd Lots trading desks forever. So a big, big change for the odd Thoughts market, so to speak. Right, so capital oh odd Lots is staying, but lower ks oh odd Lots appear to be on their way out, or at least, you know, people are still going to be making purchases in random increments, but the idea of a specific desk devoted to them, those

seemed to be on the way out. And we want to know why exactly, And we actually have the perfect guest to explain exactly what is happening. He's a recurring Odd Thoughts guest. Uh, formerly at Goldman Sachs. Mr Chris White now CEO at Bond Click and Viable Markets. Thank you so much for coming on again. Well, it's my pleasure. I want to ask though before we get started. Now, my the first three time Odd Lots guest. Uh. Yeah, We've had a number of two time guests. I think

you are the first three time. Well I was told by your producers that there would be something for me, so I'll be waiting after the show. I think it's called the Steve Martin Award a special jacket. Maybe exactly. Well, I'm world to be here. I'm actually a true fan of the Odd Lots podcast. Um, you've got a couple of of my all time favorite podcasts in your catalog, particularly the one that you did with Uh Andrew Lowe.

I think the Adaptive Markets podcast was awesome and then, um, just so listening to the origin story of how you came up with the name was fascinating for me as a true fan. But I'm happy to do what I think I've been brought in. I'm sort of the designated hitter when it comes to talking about innovation and credit.

Did you think that when you were invited on today's episode to talk about the end of Odd Lodge that we were going to be doing some sort of retrospective and yet you were actually gonna talk about the end of the podcast. Okay, so absolutely, and I'm not embarrassed to say that. But I received an email from your producer saying we want you to talk about the end

of Odd Lots. And I replied and I said, I'm really sorry that the show is going away, thanks for having me on the farewell and Uh he was like, I don't know what you're talking about, but as you can you can see the title end of odd lots for this for this one does sound like you guys are closing up shop. But I'm so glad to hear that it's still going on. And I'm also glad to clear up what I think is a misconception about what's happening with odd lots. So let me know when you

guys want to get into it, let's do it. Okay. So the art, the articles or the the recent news items around the closing up of desks at JP Morgan and City are not that they're they're going to stop trading odd lots anymore. They're actually doing something that Goldman did I think probably about two or three years ago, which is really take the human element out of odd

lots trading in the corporate bond space. And to further add to your description, Tracy, an odd lot, I would say in the corporate bond market, not all lot odd lots are created equal. We would consider there to be odd lots and then micro lots, which would be really anything below let's call uh two hundred um bonds or two hundred thousand notional. So there's sort of an in between.

And also it's sort of changes depending on what you're trading, and and really what you look at is the trade size relative to the outstanding size of the bond is going to determine whether it's an odd lot. So anything below a million in investment grade is generally considered an odd lot, but anything below five hundred thousand in high yield is generally considered an odd lot. So before we jump into this, I want to make sure that there's

a level setting. So Chris, just on that note, before we talk about what is changing when it comes to trading of odd lots. Who would be trading odd lots currently? Like what type of investors are demanding these sort of smaller or irregular size trades. Sure, so, pure retail investors in the corporate bond space probably account for less than

half of a percent of average daily volume. They are not like the equities market, and actually the equities market of old um I would say anything prior to the nineteen sixties was really dominated by the retail investor. That is not the way the bond market works. What we're talking about is something I would call institutional odd lots,

and these are really the rebalancing trades. I would say that occur in the marketplace where you know, we have a hundred and fifty million dollar portfolio, uh, somebody tries to sell thousand dollars of it, and so what do we have to do. We've got to slice away a piece of that portfolio and liquidated. And therefore, you know,

that creates smaller sized trades in the marketplace. And just to give you a sense of the magnitude of this activity or odd lots if we call them, uh in um the corporate bond space, you know, typically eighty five to of the total trades that occur in the market on an average daily basis are in sizes less than one million. But those trades only account for about fift of the volume. So it's a lot of activity, but it's it's not a lot of volume. What is it?

So before we could talk about why it's changing or why the market structure around the trading of odd loves is changing, let's talk about why it exists in the way it currently is. Why would a bank have had to have had a dedicated desk to trade these such that they couldn't just be traded through the normal route.

Great questions. So if you look at the actual behavior of electronic trading in the corporate bond space, the dominant protocol is something called an RFQ, which I would best describe to your listeners is it's an electronic phone call, and it's you, as a as a by side asset manager being able to say to the market, Hey, I'm looking for a bid on IBM five year bonds. Who's out there interested in giving me a bid? And so making that electronic phone call to ten dealers twenty uh

nine d dealers. At some at some point in time, that became the way to trade a certain type of or or to way to execute certain types of trade in the corporate bond market. But if you look a little bit further, the most uh the most popular way to trade odd lots in through something called a list form, which would be a bid wanted in competition list or an offer wanted in competition list. We call it b

wicks and oh wicks in the business. And what that is, it's a list of individual accusips that you want to trade. And typically these lists, the individual line items are pretty small. You know, five bonds here, twenty bonds there. Now, these lists used to be processed manually, and typically a list would take I would say maybe three to four hours to process from front to back. And the dominant electronic trading system and credit uh place I worked for called

market Access. Their their claim to fame, they're They're. What they solved was turning that process, the list trading process, into something that was leveraging technology. And nobody could deny the efficiency of turning something that took four hours into ten minutes. Nobody could deny the benefits of it. So imagine you're an asset manager. You need to buy your

sell a group of bonds. An electronic system is the best way to do it because you can tell a bunch of people these are the bonds I'm interested in trading, and the system will then take all of the best bids and offers and present them back to you within a ten minute period and then you can just say trade them all and you go about your day. So I think the last time I heard it about of the volume on market Access was comprised of these lists.

So talk to us then about the decision by JP Morgan and City Group to disband the actual odd lots trading desk. What do you think is going on there

and what are they eventually moving towards. So uh markets are adapting and changing, and so the the environment for trading electronically has had some radical shifts in the corporate bond space or meaningful shifts permanent ones, and those shifts are now changing the validity of having human beings actually performed the odd lot trading function on the cell side, because it's a big coming less profitable. I believe one of the biggest changes to the biggest changes actually would

be the just growth in in in passive funds. You know, so e t fs are huge component of electronic trading, and they've been growing. I think that the fixed income et F a u UM just surpassed one trillion recently I saw, so you know, it's it's still not as big as the actively managed funds that are out there, not even close, but it is becoming significant. And if you think about what is an e t F, it's people trading these baskets of bonds that are supposed to

represent an index. So that's been driving the activity, it's really been pushing it. And then the other thing that's happened is the systems used to be set so that you know, a bye side asset manager could send inquiries out only to the cell side, so only two dealers, and so those are the people you could make your phone calls to and say, hey, do you have a bid?

But now these systems have started creating what's called all to all our few trading, which is I'm black Rock and I could send an inquiry that could show up on pimco's desk. And the impact of that is obviously greater competition. And so you're going from from particularly with market Access, a system that probably had about eighty dealers on it that could respond to your inquiry if your black Rock, to a system that now has seven people

on it that could potentially respond to your inquiry. Now, what this does for just odd lot trading or really any market is more people are in the market, it's going to become more competitive, and certain trading styles are going to go away. And I think that's where we get to this question as to whether or not human beings on the seal side should be handling odd lot

trading in a manual fashion. Chris, you mentioned the notion of basically by side players getting in on these platforms and being able to deal with other by side players. And this is probably I would say the biggest difference in the past three years or so since you first

started coming onto odd Lots. The episode is that we do have this all to all participation when it comes to corporate bond dealing, and a lot of people expected that would never happen because dealer banks basically wouldn't want to give up a really lucrative business i e. Facilitating all these bond trades. How did it come to pass? Like, what was the breakthrough moment here? Well? I think the

first thing is you is it really lucrative. It's on a relative basis market making and odd lots is not uh, something that major banks can can really you know, profit from in the same way they would from from institutional trading, so you know bespoke or or by lateral trades of significant size. That's the engine that drives profit profitability. The other thing is you have to look at the quality of h order flow that you're seeing on these platforms.

It's it's particularly low quality these lists for example that gets sent out. I mean everything's in competition. A lot of times it's in bonds that are actively traded, so the spreads have already collapsed. So you know, there's a there's a lot of energy that goes into responding to trades on these systems, and so you know, you have

to look at what the output is. The other thing that I think people are not aware of is that when you think about automated trading or electronic trading and other asset classes, especially from a market making standpoint, you think of it as being a very low risk endeavor. And I can tell you that if you're going to run a meaningful odd lock desk in which you're going to be responding consistently as a dealer, you're probably gonna

have to have, you know, a balance sheet anywhere. I mean in minimum you know, two million in up is what you'd have to have in terms of balance sheet set aside, because the bonds don't turn over that quickly. So if you're going to be a player, then you've got to hold positions and so you know, you've got to balance a bunch of things here, like is that balance sheet better used in other places? Is this trader

better and there? And they're sort of human judgment better applied to other areas of the market that could make more money, And I think that's that's one of the things that's sort of driving this decision um is what's the best way to deal with low quality order flow? And I think it's you know, put a computer around it.

So you mentioned this rise of all to all trading and this idea that a bye side player could put out some sort of request and it lands on the desk of other by side players, and theoretically someone listens to that and like, that's great, cut out the middleman, and who wouldn't want that? And tighter spreads and all that. It sounds really nice, But what are the drawback x

to that? And I think one of the first times we talked, we were talking about bond market liquidity and that was probably from time to time becomes a source of concern. And can the all to all environment offer as much liquidity as dedicated desks that hold balance sheet that are there too. What are the pluses and minuses of this new arrangement and how big can it really get? Sure?

So actually I wrote a blog about this called big foot and by side Liquidity, the theme being that these are two things that people ardently believe in, but there's no physical evidence that either one of them actually exists in a meaningful way. So you know, the the market Access in particular has been going after this all to all protocol for seven years now, and they're the most well networked apparatus for facilitating trading amongst customers. I think

that nobody would disagree with that. However, after seven years agoing after it, I think that if you look at the pure numbers, it's less than two percent of average daily market share is trading on a by side to by side basis, and this is based on market access is numbers. The other thing that we're not seeing is the details of what is trading on a by side to by side basis. I would imagine that it's the

bonds that are easiest to trade. So I think where the the the sort of misunderstanding comes into places that by side to by side trading would somehow improve overall liquidity conditions. When I think that by side to by side trading has done in not just the corporate bond market, but every other market before it, it's just allowed you

to trade the things that were easier to trade more easily. Now, is it helpful, absolutely, um, But is it addressing some of the the issues that I see on the horizon for this market. I don't think so in any way, shape or form, and mainly because the things that are people that people are having difficulty trading in this market, the liquidity issues have never been in the things that

I suspect are are trading between customers. The liquidity issues are occurring are occurring when you're trying to trade something that early trades and you're trying to trade a lot of it. And you know, that's where I think there's a hole in the reasoning that this has any meaningful

improvement on the overall state of the market. Yeah, So, Chris, I wanted to sort of press you on this point because from time to time there is that bond market liquidity issue that Joe brought up, and there's also the notion that at some point the credit market is going to experience some sort of massive sell off event after years and years of rallying and arguably seeing you know, over inflated valuations and and things like that, and people say, well,

a lot of the bond trading innovation that we've seen is sort of getting ready for that moment. So people need any outlet to trade bonds in a crisis that they can get their hands on. But when it comes to that big event, if it happens, how much are those different types of trading platforms available actually going to

relieve pressure on the market. Yeah, this is we sort of have this waiting for Godot approach to electronic trading where, thanks to you know, modernized as at classes, people in fixed income look at electronic trading as the savior and it's going to fix all of the problems, and it's just it doesn't really, it doesn't really work that way.

I don't think that. My person belief is I don't think that an electronic trading system addresses the systemic problems that are currently present in the corporate bond market, and those systemic problems are The market is almost doubled in size since two thousand and eight, but the way that it's grown, it's gotten a lot riskier. The entire universe of triple B credits, which are you know, bonds that

could be moving into high yield territory very easily. That universe is now larger than the entire investment grade market was in two thousand and eight. So these you've got a bigger market, you've got a riscue market. And the other thing that's happened is the length of the market. The duration of the market has gotten um a lot longer, so you know, typical you know, typically between uh, you know, a new issue bond was about seven point five years

in maturity. Now typical typically the maturities are sixteen years. So all of that is a big dangerous sign. Now we keep on waiting. It's almost like waiting for the flood, Like when is when a right credit market is going to correct? Well, one thing that you've seen, you've seen actually central banks turntail on their de you know, de leveraging their balance sheet or the de risking their balance sheet.

And the reason why is, I think what you're seeing now is, you know, the years and years of quantitative easing have created an environment where if you start removing the sugar from the system of this market, a bunch of companies that are really on the edge because they rely on really cheap debt that is facilitated by quantitative easing, a bunch of those companies are going to have problems fine dancing themselves, and that may start the cascading effect

of what we're looking at in terms of the Great Flood So when I look at what's what's happened with central banks where they were quite adamant that they were going to stop direct bond buying and that that they're going to try to return into the Fed funds rate to something that resembles what we all grew up with. UM. Now you're hearing a lot of caution around that because I think that we're seeing such an immediate reaction to UM, you know, changes in central bank policy and how it

affects the overall market. Now, when when it does start to happen, when you do see people needing to move large positions around UM that are that don't trade that often, that that activity is not on any electronic trading platform right now. So I don't know why we would assume that all of a sudden, the electronic trading platforms are going to be the destination of choice for UM. When when this UH pronounced volatility starts starts taking form, So Chris, just so that we don't leave it on UM a

sort of does master in the bond market. Note when when you survey, when you survey UM the structure of corporate bond trading of the market, and you look, you know, say five or ten years into the future, what do you think it's going to look like. Well, I've made a bet that it's going to look a lot more

reliable from a liquidity standpoint. And you know, I think one of the earlier podcasts I had with you guys when we talked about the modernization of the market and what needs to be built, and I ended up building it. You know, since the last time I think it was on here, we've made significant progress with building the first consolidated quote system for the bond market. And consolidated quotes are sort of the the fertilizer that you need in order for the market to grow, the garden to grow.

And what it what you're doing is you're you're putting high quality pre trade data into the market and making it readily available for everyone. Now why is this important Because you must eliminate ambiguity around or unnecessary ambiguity around the value of something in order to improve its reliability to trade it. So what we have is a market that has grown very quickly, but especially on the side of the market maker, their access to pricing data has

not improved. So you're asking a market maker to step up consistently and provide risk transfer, to provide liquidity to the buy side. But I think one of the major challenges for the market maker is they don't have enough market data to do so. And so, so, Joe, Joe looks like you have a question on this. Yeah, I just so just you know, going back to what you were talking about the cell side having to allocate balance sheet in order to uh, you know, remain a viable

player in these markets. What you're saying, basically is the only way they're actually going to do that and continue to be a part of that and to provide more liquidity or the liquidity of the market needs is if they can be comfortable that when someone calls up in one of these electronic calls for quote or for a um for a trade, they have to have some feel at the ready of what a good price should be.

And that's what you're saying, is this sort of necessary ingredient to provide and so what is that information look like that allows them to do that. What's so fascinating about your question is like it's right in front of us. Any modernized market that you look at, the market makers know what all of the prevailing prices are around them. They know the prices from other market makers so that

they're able to properly calibrate their price. You do not see markets that are You do not see any market that's considered modern without some sort of apparatus that makes it easier for the market maker to to be able to make markets. We do not have a visible market in the corporate bond space. There's no definitive best bid best offer that's been established, and so without that, you have to put yourself in the seat of a market maker.

Somebody calls you up and says, hey, Joe, I see that you've got this bid for you know whatever, IBM five year bonds. I'd love to sell you twenty million of them. What's the first thing that you're gonna want to know? Where's my bed? In the context of everyone else? Am I too high? Am I? You know? Am I? Through the offer side? All of those things, and um, the dealers simply just don't have access to that information

in the marketplace. What we've seen historically is when you give market makers that access, they trade with more confidence. They're they're able to get better return on their balance sheet because they can manage the risk better, and therefore they're willing to offer more reliable institutional liquidity. So this is not an original idea. And I think if people go back in the Odd Lots archives and they look up, I think it was called the the you know something

about the modernization of of of markets. We talked about this in length, like what happened when the equity market did this and what happened to those market makers? So what do I see in five to ten years. I'm pretty confident that because of the environmental shifts that have occurred in the market, the adaptations that are going to occur as dealers are going to become much more savvy around the incorporation of data into how they provide liquidity

to customers. They have to. They're being forced the the the limited amount of balance sheet they have to dedicate to a market that's a lot bigger requires that they have more honed risk management and inventory management techniques. And the only way that you can manage your risk and manage your inventory is if you've got access to the data. So just to put it in context for you so

you can tie it all together. If I have all of the available pricing information in the market as a dealer, and I have i'm long or have on my books a large position, I now know where I have to offer the bonds consistently in order to give me the best possible chance to get out of the position. And this is what dealers are looking for, Like I need

those guide posts. You give me the guide posts that I'm gonna be willing the next time you want to trade a big position, I'm gonna I'm gonna be willing to take it on my books because I at least have some semblance of an idea of how I can get out of it without me having to do a forced or panicked sale. And you know, these aren't the things that are being i think, discussed openly, but you can see them in the numbers in terms of the the the overall revenues declining for US corporate bond market

making year after year after year. I think that that's just telling you, hey, the environment shifted. We've got to do something differently. And I think the dealers have shown in other another asset classes that you know, after a few years of taking on the chin, they start to rethink their business model. And I think a data driven business model is right on the horizon for for the cull Side. All right, Well, Chris, it was lovely having

you on the show for the third time. You've made the odd lots, odd lots possible, so thank you, and we'll have to have you on again at some point so you can retain your title of the most frequent add thoughts guest. Yeah, I'm going to also get my Steve Martin arrow through the head apparatus for for the next one. I think it's absolutely a pleasure to be on the show and you guys are doing great work. Keep it quirky, keep it odd, and I look forward

to being back. So Joe, I don't even think I have to tell you, but I really enjoyed that conversation. It feels so nice to be talking about market structure again, and not just any market structure, but the structure of the corporate bond market, which is something that you know, I in particular, I've been watching for some time now. No, I really liked that episode two. It felt like a

classic topic for us. So it's kind of like double e meta because a it was, you know, play on our name, but more importantly, it felt right in our wheelhouse of something that we should be talking about. So I always learn a lot talking to Chris, And you know, I don't know the corporate bond market nearly as much as you do, but I find uh that sort of I mean that goes without saying, but I find like, just like thinking about these questions of market structure very interesting.

And what he was saying at the end about prices is something that I think about a lot, and probably inspired by past conversations with him, which is that I think we sort of take prices for granted. Prices appear on the screen, but someone had to get them and someone had to put them together, and that process itself

is still being worked on. Is just a really interesting idea. Absolutely, and sort of on a related point, but I thought what Chris was saying about, you know, this notion that market structure can suddenly fix all of the markets ills is just totally out of whack. And if you're actually worried about a bubble in corporate credit, then I don't think having a very sleek training platform is really going

to help you much fundamentally with that issue. It might help at the margins, but you know, ultimately you're talking about overvaluations and when the time comes to sell, it seems really unlikely that a training platform is going to help you. Absolutely and just intuitively, intuitively, it sounds very attractive, this idea that's like everyone can just you know, cut out the middleman and trade with each other on some

sleek electronic platform. But what Chris is saying and just sort of what's you know, very obviously different about the corporate bond market is just how diverse it is and how much of a range of different assets there are, and so Yes, to Chris's point, it makes a lot of sense that one of these new platforms could facilitate easier trading and the really liquid stuff that everybody might

have access to. But where there but there's so much uh, you know, esoteric paper out there in the bond market and different versions of uh any given companies paper that

that problem is still needs to be solved. Is a really good one and that's probably and just this idea that also that's stad about um, how much bigger the junk market has grown and how much longer and duration it's gotten so that the nature of the market itself has gotten significantly riskier over the last ten years is a really good one and a really good one to think about. You know this idea of an inevitable crisis

if it happens right. The triple B portion of the investment grade market is what he was talking about, and that's something that we've seen crop up a lot in recent commentaries and worries about overheating in the bond market. So we should definitely do some more episodes on that think. Thank you for clarifying. Okay, sorry, no, I appreciate all right. This has been another episode of the Odd Lots podcast. I'm Tracy Alloway. You can follow me on Twitter at

Tracy Alloway and I'm Joe Wisn'tal. You could follow me on Twitter at the Stalwarts and you should follow Chris on Twitter at Friday Newsletter and check out the Inside Market blog at www dot bond click dot com, and of course follow our producer on Twitter to for Foreheads. He's at foreheads t, as well as the Bloomberg head of podcast, Francesco Levy at Francesca Today. Thanks for listening to