Robert Hammond, Head of Client and Dealer Sales, Europe at MarketAxess, discusses with Best Execution new protocols to meet the liquidity gap in the fixed income market
What is the current state of market liquidity?
In the fixed income and credit markets there are many different types of bonds with very different levels of liquidity. One indicator of market liquidity is the US Federal Reserve numbers for US dealer Inventories. From the peak of liquidity in late 2007, dealer inventories are currently running at around 20%-25% of what they were at the height. Overall dealer liquidity remains pretty static of late.
Of course one has to appreciate that some incoming regulations are inhibiting the market. The Volcker Rule, for example, seeks to limit proprietary trading and the new regulatory environment is bearing down on the OTC (over the counter) rate and OTC credit markets. In addition, the implementation of central clearing is requiring market participants to closely review their trading work-flow.
What trends are we seeing in terms of trade size?
It’s very difficult to generalize about the market, since there is very little public data available in Europe but we do think there is a trend towards smaller trade sizes. We obviously see the volumes going through our own platform, though we cannot see what goes through other platforms, or the size of telephone trades, for example. What we do know is that fund managers often break larger orders into smaller sizes in order to transact electronically.
Typically in the US credit market, where data is available, close to 20% of trade volume is executed electronically versus around 80% via the telephone. While dealers enjoy using electronic trading, they still have a preference for doing the large ticket sizes by telephone. We handle the vast majority of those electronic trades in the US and expect the percentage to continue growing.
How is electronic trading filling the liquidity gap?
There are a couple of key ways in which electronic trading can help drive liquidity. First, as far as MarketAxess is concerned, we’ve expanded the dealer participation on the platform by adding a broader group of regional and specialist dealers, providing investors with a much larger pool of counterparties to trade with.
The second thing we’ve done is to bring buy-side counterparties together, when there is no suitable dealer price available, through MarketAxess’ Open Trading. In addition to the normal client-to-dealer RFQ (Request For Quote) transaction model, Open Trading allows our investor clients to trade directly with other investors. This is helping to increasing liquidity by further broadening the number of potential trading counterparties.
Our dealer pool in Europe comprises 26 banks who are both quoting live, streaming prices on the platform through our click-to-trade (CTT) protocol, and are prepared to respond to client RFQs. In the US, our dealer pool comprises around 80 banks. Our Open Trading protocol works in the following way: if a clients send an RFQ to a bank but cannot find an offer, they can then choose to send their request, anonymously, into the Market Lists order book where other investors can see and respond to that order. This may result in a transaction with another client.
Currently we offer the Market Lists protocol for all of our US and emerging market products, and we are finalizing the development of the same system in Europe. In Q1 2012, when we started offering clients the option to make their order requests visible to other clients, some 15% of the orders were being placed into the Market Lists order book. By the end of 2012 this had reached around 65%, and this year, on average, over 70% of client orders are being opened up to other investors on the platform.
Is the traditional trading model working in fixed income trading?
In order to demonstrate best execution, market participants must call at least three dealers. However, most clients typically want to call more than three, as one cannot guarantee that those three dealers will be able to quote on the bond issue sought. Clients will probably make four or five phone calls, but realistically, this process will not be as fast and efficient as the electronic route.
Therefore one might say the traditional model is lagging the electronic model. Transacting over the phone also requires a significant amount of physical workload in terms of manually confirming the details of a trade – including the executed price and which dealers were canvassed for their initial quotes. In fairly rapid market conditions, price slippage could be experienced between a quote being received from a dealer at the outset and finally executed upon. Ultimately that might turn out to be a much worse execution. Contrast that with getting an order executed so much faster electronically, and with a full audit trail.
Are there any new protocols being developed to meet new market demands?
The European fixed income market exhibits a different market convention to the US where trading is undertaken on a spread trading basis, as opposed to a predominantly price-based protocol in Europe. (Emerging markets also trade on a price protocol). Consequently, we are working on adapting the Market Lists work-flow to allow for these differences in trading conventions between the US and European markets.©BestExecution | 2013