THE TRANSFORMATION OF THE BOND MARKET.
Europe had led the race to electronify credit trading, but the US has overtaken on automation. Dan Barnes reports.
Automated trading of corporate bonds is coming; look busy. Thanks to the sophisticated price streaming activities of both traditional and electronic market makers, buyside desks can potentially move to low- or no-touch execution for certain liquid assets.
The potential of streaming prices in this context may be to shift trading of small ticket, highly liquid orders into bilateral execution. For buyside traders seeking validation of best execution that will require a stable source of pricing in order to certify such trades, where price is the best execution parameter.
“Maybe, when we get the consolidated tape [of bond prices in Europe, a report on which will be presented by 3 September 2021] we can get one aggregated provider of all data, and I think the costs will then come down,” says Stuart Campbell, head of trading, BlueBay Asset Management. “There is a push now for direct connectivity between myself and the banks, and I think the fallout from that will be, I don’t need to use one of the big three platforms to trade, if I can have five or six direct feeds.”
The caveat is that these developments are largely found in US investment grade credit, reversing a long bias towards greater electronification in the European markets.
Paul Reynolds, head of fixed income at execution management system provider, TradingScreen, says, “The US buyside is racing ahead, investing in technology, very clear of what they want, why they are doing it and what the outcome will be. European clients are perhaps less clear in their minds about what the future is. Yet when we describe what the Americans are doing, Europeans see the sense in that approach.”
Certainly, European banks are stepping forward to offer similar services to their buyside clients. Where electronic trading had once referred largely to the request-for-quote model, which migrated the voice trading workflow to an electronic format, the potential now exists for asset managers to fully automate some of their execution, and dealers see this as a game changer.
Describing UBS’s development of streaming prices for the European market at a briefing in April 2019, Chris Purves, head of the bank’s Strategic Development Lab in FX, rates and credit said, “It is the ‘Blockbuster’ moment; some people are still selling videos while others are streaming.”
However, this exciting development and the promise it harbours should not outshine the reality that much of fixed income trading is still an over-the-counter market for large block trades. Whether trading via voice or electronically, execution quality is still beholden to many additional factors than more flow instruments like G10 currencies or blue-chip equities.
Therefore, most buyside trading desks will find they are still fighting hard to manage execution quality in markets with limited available liquidity, a challenging price formation process and limited numbers of available counterparties.
Kate Karimson, head of fixed income product for Europe at BrokerTec, says, “No-one solved the perceived liquidity crisis, which was a big focus a few years ago, when it comes to corporate bonds execution. In the EGB space there have been relatively few disruptors. I wouldn’t say there are any particularly effective risk transfer mechanisms for block trading in either of those markets. There is a lot to be done on both.”
Motivation to electronify
Having seen many efforts to use equity-like models to solve bond trading experiences, fixed income practitioners have pushed back. They are seeking to electronify both rates and credit along lines which suit the asset class, with Europe taking a lesson from the US market. That will require an investment in technology and an evolution of market structure in order to reap the rewards.
“The electronification in benchmark US treasuries has helped from a pricing perspective, by narrowing bid offer spreads, and helping to facilitate a wider participation with different types of trading interest and flow in the liquidity pool,” says John Edwards, Global Head of BrokerTec. “Compare that to EGBs where you have a very different overall market structure created around primary dealers and recognised venues for trading and compliance, and although a significant amount of that flow is executed electronically, it’s a very different type of market trading experience for a trader looking to manage risk or put on a position.”
The first step on trading desks is to develop or buy order and execution management systems
(O/EMS) that will enable traders to engage with new trading protocols, access market data sources and provide a feedback loop of post-trade information to inform and improve the investment and trading process.
However, this has proven challenging, in part as many O/EMS systems struggle to match the workflows that bond trading desks need them to provide.
Christoph Hock, head of multi-asset trading at Union Investment says that after a very in-depth due diligence assessment for third party EMSs the firm decided to build its own. “Our conclusion was that no EMS was able to fit perfectly into our own portfolio construction and trading workflow processes,” he adds “The decision to go for an in-house solution fully takes care of our traders’ specific needs in day-to-day business. Additionally, it gives us a maximum degree of flexibility to further implement upcoming requirements in the future.”
A number of vendors are also re-engineering their own products to ensure that they offer a dedicated fixed income toolset that can deliver meaningful support to traders.
“We completely redesigned our transaction cost analysis (TCA) products a year ago and we have our first clients using it,” says Reynolds. “We realised that fixed income TCA was a very poor copy and paste of equity, futures and FX TCA, and was never ever going to work no matter who did it. So, we started with a clean sheet of paper, looking at the entire lifecycle of an order from the moment it’s received, to the moment it is executed.”
The trading venues themselves have also adapted to provide a range of trading protocols that can better support bond traders as well as to deliver connectivity to the trading desktop in order to minimise the screen real estate that is taken up by interfaces and tools.
“The ideal state for a buyside trader is not to have multiple windows and applications running simultaneously on the desktop, however, trading multiple assets at similar times using the same infrastructure can be very hard, given the nuances and differences in each asset class,” says Jonathan Gray, head of fixed income EMEA at electronic block trading specialist, Liquidnet.
“[We have] a very open architecture in terms of who we integrate with, so we would be all for encouraging anything that makes the trading process more seamless and efficient for our clients.”
The challenge for sellside firms is ensuring they are still relevant when they must commit balance sheet far more selectively while facing greater intermediation from e-trading platforms.
“Dealers are not done with this market, but they need to find a new model for selling to the buyside where their expertise lies, being selective with any particular client regarding the balance sheet that is available,” says Reynolds. “They don’t want the world to turn up and expect the same thing. They will provide balance sheets on a very bespoke basis related to clients they feel they want to prioritise.”
Equally, the buyside looking to utilise these streamed prices must feel comfortable that they can use new trading protocols – such as price streaming – to support automation on the trading desk to best effect for their end investors.
“I wouldn’t ever automate purely for the sake of trimming costs and reducing head count, or of making processes more efficient, if it comes with a burden on the very high level of execution quality which is our standard, we deliver to our clients, to our end investors,” says Hock. “For me it’s not acceptable at all that we have potentially a lower execution quality to achieve a much higher level of automation.”
©Best Execution 2019