Market maker Citadel set to accelerate credit trading transformation

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Citadel Securities’ entry into America’s $10tn corporate bond market looks set to turbo charge an electronic trading revolution in an asset class once dominated by large banks and telephone transactions, say investors and industry executives.

Ken Griffin’s high-frequency market-making firm, which acts as an intermediary between buyers and sellers of assets and handles $463bn in trades each day, started offering US investment-grade bond trading to clients in June.

The move points to the changes taking place in the analogue corporate debt market, which is decades behind equities in embracing electronic trading.

It also marks a new frontier for billionaire Griffin, whose firm has been a beneficiary of the move to high speed trading in stocks. The business, which is widely viewed as heading for a public listing, handles about one in four US stock trades.

Meanwhile, his hedge fund Citadel, which is run separately to the market maker and trades a wide range of assets, was earlier this year named as the most successful hedge fund firm of all time after making $16bn in profits for its investors.

“From our perspective it was only a matter of time before [Citadel Securities] felt like the credit markets were ready for them to enter and make an impact too, and my instinct is with a firm like Citadel, they’re only going to enter into a marketplace when they feel like they can make a sizeable and real impact,” said Billy Hult, chief executive of bond trading platform Tradeweb.

The move by Citadel Securities, which last year sold a $1.2bn stake to venture capitalists Sequoia and Paradigm, valuing the firm at about $22bn, has been facilitated by a rush of technological change in a market that, until recently, had made only halting progress since the first electronic trading venues were launched in the early 2000s.

For decades, corporate bond transactions were handled almost entirely by phone, with poor liquidity and the huge range of debt instruments available making electronic trading difficult.

But industry veterans say that the shift from stodgy analogue dealmaking to electronic trading has picked up momentum following a coronavirus pandemic-era surge, with help from so-called alternative liquidity providers such as market maker Jane Street.

“Our initial focus is investment-grade [credit] where we have the highest overlap with our existing fixed-income [exchange traded fund] business,” said Bob Cariste, head of fixed-income ETF trading at Citadel Securities. “High yield has the second most overlap, so it’s a very natural next step in the process.”

Patrick Moley, senior research analyst at Piper Sandler, said the entrance of a large market maker such as Citadel “has the potential to drive volumes higher on these platforms”.

“A lot of these larger ticket-size trades, $3-5mn trades, are being done over the phone by banks . . . there has to be an incentive for those larger-ticket trade sizes to go electronic,” he said, adding that liquidity is required “and that’s helped by market makers coming into the ecosystem”.

Already, the overall share of electronic trading in US investment-grade credit has climbed from 21 per cent in early 2019 to 45 per cent at the end of 2022, according to data from industry watchdog Finra. And while the riskier $1.4tn junk bond market is taking longer to shift gears, the proportion of high-yield credit traded electronically rose from 12 per cent to 35 per cent over the same period.

The push towards electronic trading in credit has been fuelled by two critical factors. First, the advent of fixed-income ETFs has produced a liquid and transparent market for shares in those funds, which can be traded like a single stock or redeemed for the underlying bonds — typically a basket of about 100 securities.

The resulting infrastructure for pricing and trading those ETFs has laid the groundwork for the second important enabler of electronification: portfolio trading. This is a highly lucrative and rapidly growing practice in which large bundles of bonds are electronically priced, with the underlying securities trading simultaneously in a single transaction.

“Electronic trading in the bond market has historically been traders using electronic platforms to engage dealers in a [request for quote] format where they are manually trading,” said Chris Concannon, chief executive of trading platform MarketAxess. “They’re now using full automation. This has been over the last couple of years growing quite aggressively.”

Citadel Securities’ entry into investment-grade credit builds on its existing business in market making for fixed-income ETFs, which already required it to act as a market maker in those funds’ underlying bonds. Jordan Cila, global head of fixed-income distribution at the firm, said that of the 100 clients for its credit business, “much of that has been clients onboarded from our existing client base”.

Cila said the firm was aiming to sign up about 350 clients — about a third of its global client base — by the year’s end. “We are not limited by client demand but more dependent on how quickly we can expand while making sure the client experience is of the highest quality.”

The opportunity in credit for firms such as Jane Street and Citadel Securities has widened as regulations following the 2008 global financial crisis have pushed big Wall Street banks away.

John McClain, a portfolio manager at Brandywine Global Investment Management, described Citadel’s entry into investment-grade credit as a “natural progression” but added that high-yield corporate debt was “a different animal. The quality of data in high yield is severely lacking relative to investment grade.”

Citadel’s Cariste acknowledged the market for high-yield credit was “less electronified and more idiosyncratic, so it requires some further refinement in how we’re leveraging our existing franchise”. He said “the goal” is to launch trading in investment-grade credit at about the end of the third quarter or early in the fourth quarter, “then single bonds and portfolio trading in high yield credit” later that quarter.

However Citadel Securities’ new venture fares, global fixed-income markets have reached a “tipping point”, according to Audrey Blater, a senior data analyst at analytics company Coalition Greenwich. Even traders reluctant to trade electronically now recognise “that the writing is on the wall”, she wrote in a recent note.

“It used to be fun to go to the music store and browse CDs and tapes,” said Blater. “But would you ever give up on-demand streaming music to get that experience back? Unlikely.”