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It won’t surprise anyone reading FT Alphaville that bank trading desks have evolved a fair bit over the past decade. The most obvious aspect is how broker-dealers have basically stopped being the latter.

Bank prop desks — which at their noughties peak resembled massive hedge funds with free leverage — have been killed, and their traders largely migrated to multi-manager hedge funds. The remaining market-making operations have been constricted by regulations and dearer balance sheet.

That’s not new. But it’s still incredible to see how much the business model keeps shifting towards a pure brokerage model, where banks pretty much only act as intermediaries even in the bond markets that they have historically dominated.

Just take a look at this chart from a recent report by Coalition Greenwich.

Five years ago, US primary dealers held an average net positions of $16bn in corporate bonds, a market where the average daily trading volume was $29bn.

Last year, the average daily trading volume was almost $38bn — while the net holdings of primary dealers had collapsed to just $3.6bn in 2022. This year average net holdings have climbed back to $6.5bn, but still . . . Banks have basically gone from being massive bond warehouses, to inventory-lite, to now being virtually zero-inventory online retailers of credit.

Things are less extreme in Treasuries, where trading volumes are up by about 27 per cent since 2017 to ca $617bn in 2023 and primary dealer holdings have roughly doubled to $184bn over the same period.

Still, that is down from over $200bn of net average primary dealer holdings in 2019 and 2020.

And things looks starker when you compare the Treasury holdings of primary dealers to the exploding size of the overall US government debt market, which has nearly doubled over the past five years to $24.8tn.

You can therefore kinda see why Stanford’s Darrell Duffie (among others) think that the growing size of the Treasury market relative to the winnowed state of the primary dealers could be dangerous.

But Coalition Greenwich’s Kevin McPartland reckons that the incredible primary dealer shrinkage is both a case of musts and needs:

Dealers are using less balance sheet to trade bonds with customers because they’d prefer not to (capital is increasingly expensive) and because they don’t have to. Electronic trading, which now accounts for 40% of IG trading, 31% of HY trading and 65% of U.S. Treasury trading (full-year 2022 data), has made trading as agent or riskless principal much easier. When executions are anonymous, the trade is agency by definition, with a brokerdealer executing the buy from the seller and a sell to the buyer.

Even trades via RFQ, which could require a dealer to hold those bonds on their balance sheet, are often riskless principal with dealers now able to much more quickly source the other side of the trade via electronic markets and/or more robust data on who might be interested in what.

And then there’s the buy side. With $1 trillion of assets no longer a big deal, and technology that allows the buy side to post a price (aka provide liquidity) readily available, the largest asset managers and hedge funds are increasingly acting as the markets de facto balance sheet, where much of the bonds outstanding can sit in perpetuity.

This is less true for U.S. Treasuries, given the global demand for U.S. debt and the many reasons buy- and sell-side firms hold these bonds. But the demand for on-the-run U.S. Treasuries has created a liquid market (despite some popular opinions to the contrary) that means dealers can easily find a place for any Treasuries they can’t or won’t keep in their portfolio.

Further reading:
— The creeping equitisation of credit trading
— How bonds ate the financial system