How ETFs are expediting bond market modernization

Despite equities having long transitioned to electronic trading, over-the-counter trading remains common in the bond market. Bond ETFs are changing that. 

“It’s been a slower transition for the fixed-income markets to go more electronic and to modernize,” Joanna Gallegos, BondBloxx co-founder, told CNBC’s Bob Pisani on “ETF Edge” on Monday.  

Gallegos explained that the digitization of fixed-income securities such as bonds intersected with ETFs when they were first introduced to the exchanges. 

“They actually worked really well together,” she said. “Bond ETFs are 20 years old today, and they trade the same way as some of the technologies in fixed income.”  

Roughly a decade after equity ETFs were first introduced, the first four bond funds launched in July 2002 — the iShares 1-3 Year Treasury Bond Fund (SHY), the iShares 7-10 Year Treasury Bond Fund (IEF), the iShares 20+ Year Treasury Bond Fund (TLT) and the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD). Today, more than 570 ETFs are traded on the U.S. markets.

“There are new trading platforms that are helping create more transparency to bond buyers,” Gallegos said. “And it just sounds really familiar to the way ETFs had grown with the equity markets.”

As with most financial instruments, bonds are distinguished by CUSIP codes, which were developed in the 1960s to identify issued securities. Gallegos explained that modernizing the process is not as difficult a problem to solve thanks in part to the rapid expansion of the ETF market.

“There are thousands of CUSIPs, but there’s also a lot of technology that’s been built in fixed-income market making in the last 20 years,” Gallegos said.

In that time, ETF markets have weathered volatile events from the global financial crisis to the Covid-19 pandemic. Gallegos said the ability to trade in a more structured way offers investors assurance they can source liquidity when they need it.  

“We think it’s going to accelerate really quickly from here,” she said. “And what we’ve observed is there aren’t enough fixed-income ETFs.”

According to BondBloxx, bond-based funds represent just 20% of the ETF market. But the firm’s outlook sees persisting market volatility in 2023 as fixed-income asset classes have potential to deliver better returns in the months ahead.