Electronic trading in fixed income – the opportunity for CTOs

Electronic trading in equities markets has been powering full steam ahead over recent years, driven in part by regulatory requirements for reporting and transparency, as well as the growing availability of order and execution management (OEMS), as well as reporting tools. Many of the benefits of electronic trading – facilitating trade capture and straight-through-processing, post-trade processes, risk management and trade reporting – have been well established in these markets.

Fixed income and credit markets, by comparison, have lagged. According to a Barclays Fixed Income Markets Structure Survey, published in August 2021, around 17percent of surveyed firms still execute less than 25percent of their trades electronically, while 25percent execute less than half electronically. But credit markets have made significant strides over recent years and industry experts predict that 2022 will be a banner year for electronic trading.

At the FIX Trading Conference on March 24^th, Bob’s Guide sat down with Matthew Coupe, co-chair of the FIX community to discuss the future of electronification in fixed income.

Coupe is a staunch advocate for industry collaboration, and believes that both financial firms and fintechs should have a seat at the table, alongside the regulator, when discussing trade reporting standards. This is doubly important for credit instruments, Coupe explains, where the sheer complexity of bonds as an instrument creates reporting hurdles.

“If I’m trading a very simple, very liquid instrument, I can do that in an automated manner. And then if I’m trading a more complex product, then I need to spend time on it. That can’t go through an automated process and generally probably goes to phone trading when we’re talking about FI,” Coupe says, highlighting the complexity of the problem faced by fixed income traders.

“What we’ve also had in Europe, and particularly when we’re looking at data standards, is that MiFID II brought in the biggest ever transparency regime we’ve ever seen. The scope of instruments included was massive. And that’s brought a lot of complexity for us as an industry, not challenges in terms of where we need to go, but what we need to evolve on.”

Transaction cost analysis and the evolution of data

Following the advent of Mifid II, the drive for firms be able to demonstrate best execution has intensified the hunt for a reliable provider of transaction cost analysis. Alongside trading systems is another area where equities have led the fray. A number of TCA providers, including both exchanges and data specialists, have made headway in the market with well developed products for equities.

But beyond satisfying a reporting requirement, Coupe believes that there are operational efficiencies to be won by carefully considering the selection of a fixed income TCA provider, who actively engages with the industry dialogue on data standards.

Coupe is agnostic on the matter of building versus buying trading software and TCA for fixed income. What he does advocate for, is a stringent focus on the data management capability of any OEMS, as well as a firm’s reporting solution.

“I think in fixed income where the challenge comes in, is that TCA is driven by large volumes of data. And so what you need to look at is applying the specifics of how a particular instrument trades because credit doesn’t trade on an order book in the large majority of cases,” he states.

“So there needs to be careful consideration of the attributes you’re using to benchmark TCA. This is a data-hungry process and it takes a long time to evolve. Stakeholders need to be engaged and willing to go through that path of engaging with imperfect data to improve it. In fact a lot of the TCA providers among the membership of FIX are already engaged in that debate and working to develop industry standards for TCA.”

CTOs and business decision makers should be involved in the debate

According to Coupe, engagement can be beneficial both for individual firms and the broader industry, ultimately resulting in increased electronic trading volumes, improved transparency and clearer data standards and regulation.

The FIX co-chair advocates for engagement both on the part of financial firms and technology providers.

“You have to be involved in the discussion [on data standards] because it’s about actually understanding data as to whether you are a trader, whether you’re a technologist, whether you are a consultant, a lawyer, you’re always looking at the data and looking at what’s happening from a different angle and you need to understand the context. So if you don’t get involved in the debate and discussion, you’re going to be left behind,” Coupe adds.

The definition of portfolio trade, i.e. bulk trading of a basket of bonds, versus technical trades, or the purchase of a single bond,  iis one key issue that’s been occupying Coupe’s time as part of a FIX working group on reporting. Portfolio trading as a practice has grown exponentially in recent years, driven by a rise in passive investing.

According to the ICE, as of 2021, portfolio trades accounted for 5percent of all fixed income volume on the exchange. This growing volume highlights the need for universal data standards for reporting.

“It’s important to standardise, what can we classify as actual liquidity that is being traded on the market versus technical trades, the co-chair said, honing in on a specific part of a far-reaching and pervasive discussion at the conference.

As tends to be the case with all data management, the way to end up with accurate and useful trade reporting standards is to begin by asking the right questions. This is where firms can engage with the industry and have a real chance of influencing the discussion.

“In fixed income, as we’ve seen an explosion in the demand for data, the key is trying to decide what’s happening in the marketplace. So when you when you see the buy side members of FIX, it’s about actually getting the data, implementing a central source of truth and being able to display it,” Coupe concludes.

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