Is There Too Much Choice in Fixed Income?
The following blog post is by Brian Cassin, head of product & strategy, North America at Vela, and has been republished with permission.
Navigating price discovery and execution on the fixed income markets is time consuming and costly. Many platforms and venues have launched over the last few years in an attempt to make trading easier. Now there are so many that the market has become more complicated. Unless investment firms can connect to platforms and liquidity easily, they are faced with too much choice. There is a high level of risk – and potentially cost – attached to any connection, and firms need transparency before these trading choices can really become advantageous.
What sits behind these changes is a tail-off in dealer-generated liquidity. In bond markets, which have inherent illiquidity, the impact has been most noticeable.
Trading venues have launched across fixed income markets in order to fill the void created by the concentration of market makers on the most liquid securities. From rates to credit, cash and derivatives, more than 100 venues have been created in the last few years. Some of these are using genuinely innovative new trading models, particularly all-to-all which has proven successful in the credit space, but no matching mechanism can make up for a lack of buyer/seller to your trade.
The inherent problem is the number of non-fungible instruments traded in any market. While government bond markets only have one issuer, corporate bonds have an enormous range, as do municipal bond markets. Each of these issuers can issue debt at any point in time as they need. The bonds issued have a variety of tenors, resulting in an enormous universe of potentially tradable instruments. These are divided up across investment grade, high yield, and emerging market debt for investment purposes.
Every fixed income instrument set has a cluster of successful – and many less successful – venues with the potential to help connect buyers and sellers. For the buy-side trader, this would appear to be a positive route to finding liquidity. Over the last year, dealers have been moving back into these markets. For the sell side, fitting into this new landscape can create a wealth of execution options and ways to reach new clients.
However, the sheer number of platforms is paralyzing. For each venue, data feeds need to be analyzed, implemented, and tested. Connectivity needs to be set up and legal agreements need to be reviewed and negotiated in order to start engaging with any one venue. Data then needs to feed seamlessly onto the trading desk, whether it is buy side or sell side, and preferably without occupying too much screen real estate.
Larger markets which operate a request-for-quote (RFQ) trading model do not display prices. Buy-side firms have to reveal their interest to a certain number of counterparts in order to get a price. Many buy-side firms are building data feeds that allow them to understand where a price should be on a pre-trade basis, so they can minimize information leakage. That is an additional cost.
These mounting expenses neutralize the advantage that platform competition can confer.
Start-ups will often have constructed platforms using the latest technology while incumbent venues are built on older systems – there is no standard interface. It is crucial that firms assess their ability to normalize data feeds and trading connectivity early on in the process, to ensure each trading desk can benefit from these new innovative venues.
Reaching every platform is impossible. Even connecting to several for a single instrument can outweigh the benefits they offer. Some platforms have already fallen by the wayside. The risks of forking out for connectivity to a failing venue can impede the business goals further.
For a heavily voice-traded market, the introduction of electronic trading channels is still relatively fresh. Buy- and sell-side firms seeking a route to access liquidity more easily will have to start with the nuts and bolts; working out how to get low-cost connectivity first, will make the economics of the wider market work and find real opportunity in the expanding ecosystem of fixed income trading.
The future, for both buy side and sell side, lies in technology that enables greater transparency around pricing, quoting, and trading. It is only when firms can see and compare prices and quotes from multiple venues and counterparties, that best execution in Fixed Income will start to become more meaningful.
Major innovation is two to four years away.
Only 157 corporate bonds out of 39,000 were deemed liquid.
The figures show how many instruments are classified as liquid.
Challenges include illiquidity and fragmentation across borders.
Tradeweb reports a fivefold increase ahead of MiFID II.