The current fixed income trading environment is creating a ‘perfect storm’ for fixed income trading technology. The combined impact of regulation, record low interest rates, continued strong issuance, and fragmented liquidity is posing new challenges for fixed income traders. Technology is now being sought to provide many of the answers.
In November 2014 ICMA published a report on the current state and expected future evolution of the European investment grade corporate bond market. This report analysed input from 34 representative firms across sell-side, buy-side, issuers, and e-trading intermediaries/platform providers. The report re-affirmed a widely-held consensus that alongside traditional voice/chat trading, fixed income e-trading has increased and evolved since 2009, and should continue doing so for at least for the next few years. The same report estimated that currently around 40% of all European investment grade credit transactions are now electronic, although this still remains predominantly for smaller tickets. For European credit indices (iTraxx) approximately 90% of the trades are now electronic. The same trend is clearly evident in fixed income markets around the globe, from the Americas to Asia-Pacific. In a recent blog article, John Greenan found over 80 venues where fixed income deals could (at least in theory) now be transacted electronically; a sharp increase since 2009 and the number continues to grow. For regulated fixed income and credit derivatives markets including SEF’s, the number of trading venues has mushroomed in the last three years; many are expecting some consolidation to follow.
At the same time, dealers have continued to scale back bond inventories and capital they risk in making markets in fixed income. Regulation has been a key factor. These traditional providers of liquidity have generally become less able to fulfil this role – many are now looking to trade more as agents without taking on larger positions and risk. The less liquid corporate bond markets which tend to attract higher tariffs under current regulation, have been among the worst impacted.
Low rates, strong issuance; demand continues for bonds
While interest rates remain at record lows, issuers have continued to seek to finance themselves at attractive rates – and with some European government bonds offering negative yields, investors continue to buy. This remains a strong driver for new bond issuance. Since 2011, Euro-denominated investment grade issuance volume has climbed over 110% - from €75Bn to over €160Bn. (source: Dealogic)
More data – how to use it for profit?
Having the right information at the right time is generally key to trading profitably. A couple of examples:
How to find the ‘best price’ for a fixed income deal used to be an easier question to solve before 2009. For many this now represents a significant challenge in the fixed income markets. Added to this, by 2017, MiFID II will place an obligation on professional fixed income investors to demonstrate ‘best execution’ when they trade in fixed income.
For many traders, current practice usually amounts to a ‘screen grab’ or even manual input of comparable pricing at the time of capturing a deal in their systems to demonstrate ‘best execution’. Whether this inefficient practice is sufficient to withstand a regulatory challenge, remains to be shown.
The problem in fixed income, is that the pricing information one needs is disparate, and increasingly spread across a growing range of sources. It’s becoming necessary to integrate liquidity and pricing from sources as diverse as broker screens, multiple trading platforms, emails, chats, web pages, regulatory feeds such as TRACE, and potentially from newer sources including B2Scan, Project Neptune, Xtrakter and others.
Then one needs to classify this information according to its value – preferably automatically and in realtime. Is the price from a reliable source, or useful merely as indication? Some trading platforms are starting to do offer this for their own pricing – but this still only covers their part of the market.
To cross-check, continuous reference pricing against spreads, benchmarks, or curves is also now being factored into the list of quotes to be considered when trading.
Being able to automatically aggregate, rank, and grade all of this quote information in a single personalised display for every instrument one is trading can make a significant difference to profitability, even over the short term.
The activity of trading generates data which is in itself valuable business intelligence: for example the full history of past enquiries and client trades can be used to inform traders/salespeople who to contact to get the next deal done. Having it immediately available can make the difference between winning or losing the deal. However due to technology limitations much of this data is not currently tracked, and is therefore lost. Those that can harness it properly, get an edge on those that don’t.
Where and how to execute the trade?
While voice and chat trading continue to provide a key part of the fixed income trader’s arsenal, electronic trading across an increasing array of platforms will likely become more important with time. The decision of where and how to execute the trade is also a key factor in profitability. The available liquidity, the bid-ask spread, the cost of execution, and any ancillary benefits – such as the information or data one receives back as a result of the trade – all need to be factored into the trader’s execution decision.
Integration and STP: Cutting costly errors and wasted efforts
Human error from entering trades incorrectly can lead to failed settlement and possibly also to fines. Lack of clarity on positions can cause traders to take on unintended risk from trades. Aside from the wasted effort and time given to manual trade entry and administration, the costs of these errors are a hidden tax on the profitability of a trading desk. Integrating systems to ensure that as much information is captured automatically, can significantly benefit profitability.
The way forward
Integrating all voice, chat and electronic workflows together with all the information sources one needs, into a single fixed income trading tool, is an attractive proposition for a fixed income trader. New technologies have started offering the solutions the fixed income trading community now needs. For example, AxeTrading, recent winner of the bobsguide and PaymentEye Fintech innovation award for the best trading system (buy- and sell-side) is at the forefront of this movement. No doubt others will follow.
By Mark Watters, Director, AxeTrading