September 19, 2023 | Stamford, CT — The biggest U.S. bond dealers are maintaining the bulk of their market share while morphing into bond brokers who facilitate trades without putting their own capital on the line.

Primary bond dealers traditionally maintained large inventories of bonds used to take principal positions to fulfill clients’ bids and offers. In 2017, primary dealers held an average aggregate net position of $16 billion in corporate bonds, while daily market volumes averaged $29 billion per day. In 2022, the net position dropped 77% to $3.6 billion while trading volume grew 29% to nearly $38 billion.

Dealers began reducing bond inventories after the passage of the 2010 Dodd-Frank Act, which increased capital reserve requirements on banks in the wake of the global financial crisis. Their gradual transition from a principal model towards an agency model occurred in step with the growing electronification of bond markets. Electronic trading, which now accounts for 40% of investment-grade trading, 31% of high-yield trading and 65% of U.S. Treasury trading (full-year 2022 data), has made trading as agent or riskless principal much easier.

“The growth of electronic trading has also allowed the buy side to supplement dealer balance sheet and provide liquidity,” says Kevin McPartland, Head of Research at Coalition Greenwich Market Structure & Technology and author of The Changing Role of Primary Dealers in the U.S. Bond Market. “The largest asset managers and hedge funds are increasingly acting as the market’s de facto balance sheet, where much of the bonds outstanding can sit in perpetuity.”

Shifts in the Competitive Landscape
These shifts in market structure have impacted the market share of bank and nonbank dealers alike. Trading-related revenue for U.S. Treasuries is still largely with the top dealers, whereas in U.S. corporate bonds, smaller banks and nonbanks have made more inroads. Today, the revenue share of the top three dealers in investment-grade corporate bonds is largely back to where it was pre-pandemic, but mid-tier dealers have lost some ground.

“Across both corporate bonds and U.S. Treasuries, nonbank liquidity providers are growing, but only those that face clients directly are competing for the revenue pool of the top banks. That said, more are starting to do just that,” says Kevin McPartland. 

The Changing Role of Primary Dealers in the U.S. Bond Market analyzes changes in the businesses and strategies of U.S. bond dealers, including shifts in revenues generated by trading Treasuries, investment-grade corporates and high-yield bonds, the decline in dealer bond inventories, and changes in market share of the market’s top three dealers, smaller dealers and nonbank competitors.