THE NORDIC VIEW.
Tina Bach, chief dealer at Nordea Investment Management discusses how regulation and market conditions are impacting the Nordic region.
What impact do you think MiFID will have on the fixed income markets?
MiFID I focused on the classification of clients, reporting and best execution but MiFID II goes much further and requires far greater transparency. One of the biggest issues is the classification of bonds as liquid or illiquid. ESMA has proposed that until May 2018, a bond’s liquidity will be solely assessed on issuance size and segmented by the bond type, debt seniority and issuer sub-type. So for example, a senior corporate bond from a financial issuer is considered liquid if the issuance size is greater or equal to E500m. We are also concerned about pre and post trade transparency, especially in terms of deferral times.
What are your concerns about trying to transpose an equity framework on fixed income?
I think one of the problems is that the regulators are trying to transform and make fixed income markets more transparent as for equities. It doesn’t make sense though to impose an equity framework on the fixed income market, because it is a much more fragmented marketplace and transparency – which is a good thing in general – is not necessarily the best solution in this case to enhance liquidity. In fact it could potentially have a negative impact. For example, it could lead to wider bid offer spreads and larger aggravated market fluctuations. Also, the requirement to report trades would mean that market participants become aware of all the material information about a trade that is about to take place and this could lead to unwanted behaviour such as front-running.
Along that theme, what are the problems of imposing an equity TCA framework on fixed income?
At the moment what I am hearing is that there is no vendor system in the market that can fit the requirements for fixed income. Thus, firms are trying to build their own in-house solutions. The new trading platforms may be part of the pre- and post-trade solutions, but they are there to supplement, not replace the sellside in providing information. Multiple sources are needed.
One of the main challenges is that unlike equities, it is very difficult to get accurate information, and the more illiquid the bond, the harder this is to do. There is not enough available data to be pulled and with the level of transparency required, there is a need for greater granularity. Both our clients and compliance function are looking into how to solve this. For the buyside, best execution is not just about getting the best price but reflects all requirements of a customer’s order. Our job is to get the best returns for our clients, and therein lies the art of closing the gap between getting best execution and the reality of trading in an illiquid market.
Speaking about liquidity, there has been a lot of press on the lack of liquidity in general in fixed income. What is your outlook?
It is not just MiFID II that will have an impact but all regulations, including the new international accounting standards and the capital requirements in Basel III that are limiting liquidity. There may have been record-high bond issuance but the secondary market is not working. Trading volumes are less and ticket sizes are smaller. This is because banks are less willing to use their balance sheet and this has cut down the number of bonds they are willing to quote. They are increasingly re-evaluating their business models, switching towards an agency from a principal model. Now the buyside is holding the majority of the inventory and this has led to a rise in passive management – despite the fact that the buyside wants to be dynamic and not passive.
There has been some effort in the buyside community to try and change things, but it needs involvement from all stakeholders – issuers, regulators/policy makers, sellside as well as the buyside – in the process. I believe the liquidity will increase, but I do not see levels returning to those before the crisis. We have to get used to what has been called a “new normal”, and cannot just say there is a liquidity crisis. It is up to us to adapt to this new environment and have a view on the ongoing discussion about the buyside moving towards being price-makers and not just price-takers. We are not there yet and it might not be a solution for liquidity either.
What structural changes are you seeing?
We are seeing a number of new initiatives such as buyside-to-buyside trading platforms as well as better pre- and post-trade analytics. Some sellside houses are more reluctant to adapt to new trading platforms, but the traditional RFQ (request for quote) model is no longer working optimally. We would advocate different liquidity sources, but it needs to be done in co-operation with the sellside. We would also like to see greater standardisation, both in the primary but also the secondary market. For example, at a pre-trade level it becomes much easier to work out who has the inventory needed to trade. At the moment there are a lot of line items, and it is not always easy to know which market makers really have which securities.
How has the relationship between the buy and sellside evolved over the past few years?
There has been a great deal of talk about the buyside taking greater control, especially now as they have the inventory, However, the buyside still needs the sellside, and it is important to have a good working relationship because they still take the risk and help create the liquidity. I see the new trading platforms supplementing, rather than replacing, their liquidity in the marketplace.
We are trying to have as many counterparties as possible, including niche players, but in each case it is important that we understand how we each operate and can adapt to each other’s business models. This is why we have detailed discussions and ongoing dialogues explaining how we rank our counterparties, the way orders are worked, the pricing, settlement etc. We also don’t just talk to the sales people and traders but also the syndication managers. We must be straightforward but fair in our dealings in order to get the best service.
How have things changed at Nordea in terms of the way you operate?
We started off as a trading desk and were much more focused on pure execution, but have changed the business model since the financial crisis, increased regulation and the growth of assets under management. In total Nordea Investment Management has close to E200bn AUM and almost 600 FTE’s, including 170 investment specialists. We operate with a boutique structure, which is supplemented from carefully selected external managers.
The fixed income desk covers a broad universe including investment grade and high yield credit, rates, emerging markets, repo, futures and credit derivatives. When I first joined there was only one trader, and the desk was quite separate. Now we are five fixed income traders, in a global team of twenty-four that trades across fixed income, FX and equities. We are in constant discussion with our portfolio managers. We no longer just offer advice on how to execute a trade, but also provide information on the securities, market conditions, liquidity and flows.
What are your biggest challenges and opportunities going forward?
I would say that our two biggest challenges today are regulation and compliance, which are not the same but closely related. The most important thing to do is to take leadership when addressing these issues and to have a co-ordinated and structured approach with all stakeholders. You not only have to adapt to the new world, but also give people much more information on how you work.
As for opportunities, we are putting a lot of work into TCA and I think it will become an important feature for clients to help identify liquidity sources and mitigate risk. We are also paying attention to the different platforms being developed and how we can become involved. Our knowledge of the market landscape can assist the management group in determining how to best proceed in certain investment decisions.
The ultimate goal is for us to provide the best returns for our customers. This requires that we in trading have a handle on the latest technologies, the regulatory landscape, and maintain an open dialogue with other sellside and buyside participants. We must be on top of the game to service our clients, and proactivity rather than reactivity is the way we do business. These challenges make me enjoy going to work every morning.
Biography: Tina Bach has spent 25 years at Copenhagen based Nordea Investment Management with her latest position being chief dealer. She is currently involved in projects related to the new trading initiative and transaction cost analysis. She started her career trading Swedish bonds when interest rates were 500% as well as repos. Bach has also worked in sales targeting European pension funds and central banks worldwide and spent three years in Norway, setting up a sales desk to service local clients.