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By Olivia Oran and Trevor Hunnicutt
Feb 18 (Reuters) - Wall Street banks are ramping upbusinesses that trade exchange-traded funds full of bonds, abright spot of growth at an otherwise bleak time for trading butone that may carry unappreciated risk.
Barclays PLC, Credit Suisse Group AG andGoldman Sachs Group Inc have all created special teams tomake markets in bond ETFs. The teams include staff across stockand bond markets, since the ETFs trade like stocks on stockexchanges, but their underlying securities are bonds.
All told, 12 to 15 banks now have a presence in thebusiness, whereas a few years ago almost none did, said AnthonyPerrotta, global head of research and consulting at TABB Group.
"There are a lot of institutions that, even though theymight be retrenching in fixed-income trading, are looking atETFs as a way to galvanize their business," said Martin Small,who oversees U.S. operations for BlackRock Inc's iSharesunit, which is the largest ETF issuer.
Although these businesses are sprouting up across WallStreet, they are unlikely to make up for huge profits banksearned during the glory days of bond trading, at least notanytime soon.
Investors pay banks 0.01 percent to 0.03 percent to trade abond ETF, according to TABB Group, compared with 1.03 percentfor an individual bond. Traders say they are hoping to make upfor piddling margins by selling more of the product, since theETF business is a bulk-volume one that is rapidly growing.
The sales push comes after years of pressure from leadingETF creators like BlackRock and State Street Corp tomake markets for the bond ETFs. Those firms rake in billions ofdollars' worth of revenue from ETFs each year, and view bondETFs as a way to grow their own businesses.
Firms that create ETFs need banks to act as intermediariesfor sales, and also to ensure that prices are in sync withunderlying securities. Before banks entered the market, tradeswere handled by market-makers like KCG Holdings Inc,Cantor Fitzgerald and Susquehanna Capital Group, who have beenin the business for years.
As Wall Street has warmed to bond ETFs, the market hasquickly grown. Assets under management in the U.S. rose 44percent to $372 billion at the end of January from $258 billiona year earlier, according to fund research service Lipper. Thatrepresents about 19 percent of the broader $2 trillion U.S. ETFmarket.
While the bond-ETF boom may be good for Wall Street, it isnot without risk.
It comes at a time when liquidity in the corporate bondmarket has shriveled due to new rules that require banks to holda lot of capital against those securities. As a result, banksavoid buying bonds from investors unless they can resell themquickly, and do not maintain much inventory for interestedbuyers.
Despite their holdings, bond ETFs trade more like stocks, onstock exchanges, so they are not facing the same type ofliquidity issue. But it is unclear how they will perform ifinvestors rush for the exit all at once, or if markets comeunder serious stress. During the Aug. 24 "flash crash," forinstance, some ETFs failed to trade properly.
"I think ETFs can be great products," said GershonDistenfeld, director of high yield at AllianceBernstein. "Theyjust don't work where there's an illiquid market."
COLLABORATIVE EFFORT
Despite those concerns, bankers seem happy to be building upa business that is in high demand.
Barclays' foray into bond ETFs began several years ago, butthe bank has recently increased its marketing of the products toclients who are unfamiliar with them. The bank's head of ETFtrading, BJ Prager, said the business relies on staff who haveexpertise across stock and bond markets.
Credit Suisse launched a similar effort about a year ago.The bank's credit team finds bonds for money managers to includein the products, and its equity desk provides technology totrade and value them. Credit Suisse sells bond ETFs through bothchannels, and includes them on Nitro, its ETF trading platform,so that clients can trade more easily.
"It's a serious initiative at the firm," said RobBernstone, a managing director in equity trading at CreditSuisse.
Goldman Sachs has spent the last six months building up itsbond ETF business. Brian Levine, a co-head of equity trading whois leading the effort, said it involves "close collaboration"between stock and bond traders.
Banks have also forged close ties with firms creating bondETFs.
BlackRock and other ETF issuers allow banks to sweep bondsthat might have otherwise hogged space on their balance sheetsinto ETFs. And, each week, representatives from Blackrock'siShares business speak to bond traders at all the major banksabout the business. (Reporting by Olivia Oran and Trevor Hunnicutt in New York;Editing by Carmel Crimmins,Lauren Tara LaCapra and Andrew Hay)
