Relationship discounts in corporate bond trading

The Prudential Regulation Authority (PRA) has published a working paper which outlines the findings from a study that examined dealer-client relationships in the over-the-counter (OTC) corporate bond market using regulatory and proprietary data sets. Specifically, the study looked at the prices long-standing clients of bond dealers had to pay versus those costs clients with no relationship incurred.
As shown in the working paper, the results reveal that clients with stronger relationships with dealers enjoy much better prices, with top relationship clients paying about half the transaction costs compared to others. In fact, the top 1% of relationship clients enjoyed a 51% reduction in costs relative to the other clients. This translates to an average annual cost savings of around £1.3 million per client. The benefits of these relationships were particularly prevalent during the March 2020 dash-for-cash episode, where trading cost reductions for bond transactions more than doubled.
Various factors may explain the reduced transaction costs for relationship clients:
– Building relationships with clients allows dealers to better manage the risks associated with their inventory. For example, having a strong relationship with a client may enable the dealer to offload certain bonds more easily, reducing the dealer’s exposure to market fluctuations.
– Loyal clients who consistently trade with a dealer contribute to the dealer’s overall profits. Dealers may offer better pricing or execute trades more efficiently for these loyal clients, fostering a mutually beneficial long-term relationship.
– Finally, dealers can gain valuable insights into market trends, client preferences, and potential trading strategies by closely interacting with clients which may lead them to lower transaction costs for long-standing clients.
In the end, the study suggests that dealers value long-lasting client relationships and that they are ready to deliver certain benefits to such clients. However, these benefits are exclusive to particular clients, especially those with exceptionally large contributions to the dealer’s overall trading volume, and those unable to establish meaningful relationships with dealers face significantly higher transaction costs, particularly during times of market stress.