"The genie is out of the bottle": A senior trading exec at Goldman Sachs explains why he's so worried about the coming turn in a $9 trillion market

Goldman Sachs

Justin Gmelich spoke at the Sifma conference in Washington Tuesday.

• Goldman's top credit trader said that he's worried about a coming downturn in the corporate bond market since a decade of changes to the industry's market structure haven't been sufficiently tested.
• Justin Gmelich said the corporate bond market is "super-procyclical" these days, which makes it an imperative that the industry is ready to use whatever it can to provide liquidity when the market turns.
• Gmelich spoke to a roomful of industry executives in Washington Tuesday, at a conference hosted by the Securities Industry and Financial Markets Association. He's the chief operating officer of Goldman's fixed-income, currencies and commodities trading unit.

If you're one of the most senior trading executives on Wall Street, what keeps you up at night?

For Justin Gmelich, the chief operating officer of Goldman Sachs's fixed-income trading unit, it's recent changes to the functioning of the US corporate bond market. Gmelich, who spoke Tuesday on a panel at the Securities Industry and Financial Markets Association's conference in Washington, said the recent proliferation of products for investing and trading corporate bonds have altered the market in ways that haven't been fully tested.

"The genie is out of the bottle, we're not going back in any way, shape or form," Gmelich said. "The way we commit capital, provide liquidity, has changed materially since, let's call it 2008."

What that means is market makers - the big Wall Street banks that buy and sell securities on behalf of clients - must be smarter about the tools they use and also more alert to new forms of risk that might emerge, Gmelich said. Dozens of trading venues have sprung up in recent years to make it easier for investors to buy or sell the debt, which tends to be harder to trade than government bonds or mortgage securities.

One of the biggest changes is the explosive growth in bond ETFs, tradable baskets of sometimes illiquid debt securities issued by corporations, Gmelich said. There are now more than 80 different corporate bond ETFs, according to ETF Database.

More broadly, companies sold $1.65 trillion in debt last year alone, according to data collected by Sifma, to take advantage of low interest rates. Most market participants expect those favorable trends to slow and eventually reverse as the Federal Reserve continues to raise rates. When the market turns and clients look to unload large blocks of bonds, Wall Street firms will have to be ready to step in or else watch prices plunge.

"I'm super concerned about micro structure in the advent of a bear market," Gmelich said. "The new micro structure in credit has not really been tested."

In addition to ETFs, the bank also uses total return swaps and other instruments to get exposure to certain positions without actually owning the bonds. Goldman has also restructured its bond-trading desks so that any trade smaller than $2 million isn't touched by humans, freeing them up to work on bigger trades, he said.

At one point, Goldman's bond traders were getting a client inquiry every six seconds. To lighten the load, the bank developed a technology solution called a pricing engine that can price 14,000 different bonds, he said. That's provided an advantage of not just telling traders about bond prices, but also the value of ETFs tied to similar bonds.

Using technology to make trades, known in industry parlance as "low touch," versus the high touch of human hands is "a huge evolution in how the corporate bond market operates and it's critical to get it right," Gmelich said to an audience of industry colleagues. "It's a super pro-cyclical market now and we need to make sure that we have every tool at our disposal when it does inevitably change."

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