Cross the widely known benefits of electronic platforms with the massive but unfamiliar-to-most world of bond trading, and you get MarketAxess (Nasdaq: MKTX). The question isn’t if their fixed income marketplace will win or even when, but just by how much.
Though the global bond market ($102.8T outstanding as of the end of 2018) is nearly 38% larger than worldwide equities ($74.7T market cap, both as per the Securities Industry and Financial Markets Association’s SIFMA Capital Markets Fact Book, 2019), most fixed income assets are a couple decades behind stocks in terms of how they are traded. Other than in the most liquid categories (e.g. US Treasury bonds), market structure is primarily still over-the-counter: a network of the largest broker-dealers (e.g. JPMorgan) and institutional investors (e.g. PIMCO) quietly determine prevailing prices. Like calling up a cab dispatcher 15 years ago, smaller-scale investors who want to participate must just accept the outcomes chosen by those in the market who dominate the volume of transactions.
Unlike equities which trade predominantly on-exchange, fixed income has by far fewer retail investors, more buy-and-hold positions (e.g. investing from insurance companies), and overall simply many more individual assets. After all, a single company like AT&T can have one stock ticker yet 200+ tranches of debt outstanding. All of these have helped the traditional market leaders maintain high barriers to entry in bond trading; for example, see FINRA Regulatory Notice 19-12 about a proposed pilot program limiting corporate bond block trade information. MarketAxess is at the forefront of making bridges across such moats as it leads the adoption of electronic bond trading and thus is set to capture and create large amounts of value.
The high network effects inherent in digital platforms and marketplaces create large first-mover advantages. In recent months, US investment-grade and high-yield corporate bond trading averaged $26.7B per day, of which ~$6B (22.5%) was through MarketAxess, which is 40% more than their-next largest competitor in that space (Tradeweb). As US assets represent about 1/3rd of the global fixed income markets (i.e. the largest subclass), winning here and attracting more and more users naturally feeds growth and eventual domination in other bond markets as well. The firm is already leveraging its might by acquiring once-peer LiquidityEdge to gain access to the giant US Treasury market and similarly expanding into Eurobonds, emerging markets, and muni bonds.
MarketAxess is also well situated in these new areas to win as a result of regulations like MiFID II in Europe, which among myriad other topics require greater visibility into bond trading. The natural effect of this pushes trades onto exchanges and digital platforms in order to restore liquidity in a way compatible with new rules. Though similar changes may be slower to come to the US markets (see the FINRA pilot program mentioned above), over time whether via regulatory impetus and / or simply user demand, the significantly better transparency offered via exchanges is expected to naturally shift trading volume towards the likes of MarketAxess.
Economists tend to view technological advances as manifesting in the form of cost reductions. Providing greater liquidity, efficiency, transparency, and pricing discovery benefits everyone (except the entrenched broker-dealears) in the corporate bond ecosystem. In the investment grade space alone, MarketAxess had saved users more than $200M already in 2018 relative to traditional trading methods, an amount sure to have increased in 2019 and even further going forward. The firm uses this entry point to then cross- and up-sell higher-value services, like Transaction Cost Analysis or automated post-trade compliance reporting functions.
Increased efficiency in bond trading trickles down to “mom and pop” investors as well, who tend to engage in the asset class via bond funds. As smaller trades become less costly to execute, fees passed on the end-investor fall and attract more inflows. While very large-scale bond trades from the institutional investors still dominate volumes, smaller ones are getting easier and more common alongside electronification. This value gets shared throughout the fund system and results in all participants down the chain saving as well, even if they don’t directly engage with the newer technology themselves.
In short, MarketAxess captures value by more efficiently intermediating via its all-to-all platform for fungible bond transactions (like Uber) and creates value by also supplying associated products and services (like Amazon). MarketAxess, its users, and bond investors win big together, and some massive financial institutions lose a little.