MARKETAXESS
ON
MARKETAXESS BID-ASK SPREAD INDEX (BASI)™
A More Informed Picture of Market Liquidity
In the European Corporate Bond Market
MARKETAXESS
ON
MARKETAXESS ON is a forum for thought leadership and
discussion on the subjects and issues that are shaping
the evolution of electronic trading in the credit markets.
With internal resources and third party experts, we are
developing research, insights and ideas aimed at bringing
new levels of innovation, connectivity and efficiency to the
MarketAxess community of clients and dealers.
The MarketAxess
Bid-Ask Spread Index (BASI)™
A New Way to Measure Market Liquidity in the European Corporate Bond Market
INTRODUCTION
Regulatory changes are driving important shifts in the credit markets. The incoming
Basel III capital requirements are limiting dealers’ ability to hold risk-weighted assets,
such as corporate bonds, restricting their market-making abilities in those instruments,
and thus reducing credit market liquidity and turnover. Confronted by the challenge of
buying and selling bonds in these difficult markets, where opportunities for real return
are scarce and trading costs are increasing, investors are seeking a more informed
picture of market liquidity to help identify trading opportunities and reduce their
execution costs. The MarketAxess Bid-Ask Spread Index (BASI)™ was developed
to serve this need.
EMPOWERING MARKET DATA
MarketAxess Research developed the European BASI as a way to quantify European corporate bond market
liquidity. This new approach enables a comparison of the prices quoted for actively traded bonds over time.
The development of the index was made possible by access to more detailed Eurobond trade data following
MarketAxess’ acquisition of Xtrakter Ltd. in 2013.
Xtrakter is a leading provider of capital markets data, operational risk management, trade matching and
regulatory reporting services to the global securities market. Under the Markets in Financial Instruments
Directive (MiFID), Xtrakter is an Approved Reporting Mechanism (ARM) to the UK Financial Conduct Authority
(FCA) and other European regulators. In 2013, Xtrakter processed 1.12bn transactions on behalf of its user
community and published pricing data on over 69,000 bonds.
It processes approximately 65% of fixed income transactions
reported to the FCA.
As there is currently no consolidated trade tape in Europe that is
comparable to FINRA’s Trade Reporting Compliance Engine (TRACE)
in the United States, many of our investor and dealer clients have
expressed interest in data that can increase the transparency of
the Euro and Sterling bond markets. This, in addition to the rising
demand for more efficient execution, better tools for transaction
Today, many of the world’s
largest asset managers use
the BASI as a barometer
of transaction costs as
well as a snapshot of
overall market liquidity.
cost analysis, and new measures of market liquidity led MarketAxess
to develop its proprietary index.
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LIQUIDITY AND THE CORPORATE BOND MARKET
Liquidity is a measure of the ease with which a bond
the dealer, as it seeks to find the opposite side of
can be traded and can be approximated by the overall
an investor-initiated trade and then execute both legs
cost of trading the bond. In over-the-counter (OTC)
simultaneously, incurring little or no market exposure.
markets such as corporate bonds, the cost of trading
Working as an agent, the dealer does not hold the
is defined primarily by the difference (‘spread’)
bonds on its balance sheet, freeing it from having
between the price at which a broker-dealer is willing
to commit capital.
to buy a bond (‘bid’) and the price at which it is willing
to sell (‘ask’ or ‘offer’) the same bond. In addition to
However, because of the illiquid nature of the corporate
the credit risk associated with holding a particular
bond market, when on a typical day a relatively small
bond, the bid-ask spread is related to the length of
number of bonds trade with any frequency1, dealers
time a broker-dealer believes it will have to hold that
traditionally act as a principal. In a principal-based
bond before selling it.
transaction, the dealer executes a single side of
the trade and, in many cases, holds the bonds until
In order to facilitate fixed income trading for its
the other side of the trade is found at a later date.
institutional investor clients, a broker-dealer can
During this period, the dealer is subject to changes
either act as an agent or as a principal for a trade.
in the market prices of the bonds it holds and will
An agent-based transaction is effectively risk-free for
price trades accordingly, thereby passing along a “risk
premium” to the client for effectively renting its balance
sheet. As such, the bid-ask spread serves as a proxy for
corporate bond market liquidity.
METHODOLOGY
The MarketAxess European BASI tracks
A NEW WAY TO MEASURE LIQUIDITY
all of the bonds with trades reported to
Tracking bid-ask spread movements is straightforward
Xtrakter over a given time period. The
for individual bonds. However, for the purpose of an
spread difference between buys and
index, aggregating the bid-ask spread of multiple
sells is calculated for every bond with
bonds to accurately represent the market as a whole
reported trades, and then an average of
is challenging. Most fundamentally, which bonds do
the differences is calculated to represent
you select when the majority trade infrequently? How do
an estimate of the day’s aggregate bid-
you weight each bond’s bid-ask spread against others?
offer spread.
At what frequency do you recalibrate the index?
Daily point estimates are then used to
The approach of the MarketAxess European BASI takes
calculate an implied index value using
into consideration these and other factors to create an
a LOWESS-procedure, a commonly
index that accurately tracks overall credit market cycles.
used regression modeling method that
CREDIT MARKET CYCLES AND THE BASI
stands for “locally weighted scatterplot
smoothing.” On days when less than one
The bid-ask spread of a bond fluctuates according to
percent of the constituent group can be
the issue’s creditworthiness and changes in market
priced, the index is not calculated.
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1
On average, only 18 bonds trade on both sides (i.e. bought and sold) 10 times or
more each day, representing just 12% of the overall daily trading volume for U.S.
high-grade bonds. (Source: MarketAxess Research)
volatility. The BASI, as a broad indicator of market liquidity
We can also use the European BASI to compare transac-
and implied transaction costs, allows us to observe and
tion costs across markets. The Euro high-grade (HG) BASI
explore these relationships further.
is tighter than the Euro high yield (HY) BASI indicating that
– as expected – trading costs in the HY market are higher
Under normal market conditions, when dealers can use
than the HG market. A similar pattern can be observed in
their balance sheets freely to support market making
the sterling market. Interestingly you can also compare
for clients, the bid-ask spread is generally narrower,
across markets and currencies, for example to see how
reflecting both a lower inventory risk for dealers and
much lower trading costs are in Sterling denominated
lower trading costs for investors. However, during periods
HG bonds as opposed to Euro denominated HY bonds.
of increased volatility, dealers tend to buy at lower prices
and sell at higher prices, and bid-ask spreads tend to
widen reflecting the increased risk and transaction costs.
HISTORICAL BID-ASK SPREADS
ADDITIONAL APPLICATIONS OF THE BASI
The MarketAxess BASI can be created for specific
market sectors, trade size categories and credit
products, including U.S. high-grade bonds (USHG),
The MarketAxess BASI typically reflects broader credit
HY bonds, emerging markets bonds and most recently
market cycles. When looking at historical bid-ask spread
euro and sterling-denominated corporate bonds.
data, there is a fairly clear correlation between the index
and specific events or periods where risk-taking by
The index can also be calculated on a daily, weekly,
dealers and investors has been impacted. For example
monthly or quarterly basis. The European BASI helps
during the credit sell-off in the early summer of 2013
market participants identify pockets of liquidity where
the European BASI widened out reflecting greater price
opportunities to trade bonds more efficiently and at
volatility in the market.
lower costs might be revealed.
THE EUROPEAN BASI
The European BASI has been
calculated for both euro and
sterling corporate bonds,
in high-grade and high yield.
By comparing the two currencies
we can see, for example, that
the euro BASI is much tighter
than the sterling BASI,
reflecting a larger market in
euro-denominated bonds and
comparatively better liquidity.
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THE BASI AND E-TRADING
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BASI (based on MarketAxess trade data)
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MarketAxess BASI (based on TRACE data)
The chart shows two variations of
the MarketAxess USHG BASI, for
which we have data going back
several years. The BASI chart in
gold dating back to 2001 is plotted
using MarketAxess trade data and
represents the average bid-ask
spread just for electronic trades
on the MarketAxess platform over
the period. The BASI chart in blue,
starting in 2008, is compiled from
TRACE data and represents the
average bid-ask spread in the market
as a whole. The difference between
the two charts is equivalent to the
difference in bid-ask spread achieved
through electronic trading compared
to the spread in the overall market.
It is clear by comparing these two
indices that consistently tighter
bid-ask spreads are achieved when
trading electronically.
IN SUMMARY
Given market structure changes brought about by regulations and a market environment where opportunities
to improve yield are scarce, institutional investors are more challenged than ever to actively manage their
bond portfolios. According to MarketAxess Research, liquidity is concentrating around a relatively small
number of more recent ‘benchmark’ issues, or large new issues from well-known companies. These bonds
tend to be more liquid, trading with greater frequency and tighter bid-ask spreads. Investors wanting to trade
bonds that fall outside of this category, however, face a market that is less liquid and highly fragmented,
where transaction costs can represent a greater percentage of their real returns. In such an environment,
a new way to measure market liquidity is welcome.
The MarketAxess BASI offers institutional investors a more informed picture of overall market liquidity.
The BASI can also serve as an important tool in an overall strategy to help drive trading and cost
improvement strategies.
The MarketAxess BASI is available at: www.marketaxess.com/Research/BASI
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For more information,
please contact:
Alex Sedgwick
Head of Research
+1.212.813.6078
Visit our website:
marketaxess.com/Research/BASI
©2014 MarketAxess Holdings Inc. (the “Company”). Confidential and proprietary information of the Company. None of the information contained
herein may be excerpted, copied, disseminated or otherwise disclosed to any other person without the Company’s express written consent.
MarketAxess Corporation, member FINRA and SIPC. MarketAxess Europe Ltd. and Xtrakter Ltd. are regulated by the Financial Conduct Authority.