Fixed Income trading is about to hit “refresh.” As global debt markets have evolved in an era of increased regulation and low rates, so too has the push toward electronic trading. The migration has varied across each fixed income market: Deeply liquid markets such as U.S. Treasuries and the repo market have seen the largest migration to electronic trading, while shallow, thinly-traded markets such as high-yield and municipal bonds still tend to be brokered over the phone. All fixed income markets have an electronic venue for price discovery, but the breadth and depth of the market will determine how much trading is transacted “on the screen” versus a phone call, instant message, or a combination of all three.
Over the past two decades, a good deal of time and money has been spent on electronic fixed income trading, occurring in fits and starts. Brokers lead the charge early on with sellside-dedicated interdealer (D2D) systems such as BrokerTec and eSpeed. Third-party platforms and alternative trading systems, such as TradeWeb and MarketAccess were next. Initially, these ATS platforms connected the buyside and sellside (dealer-to-consumer, or D2C), and more recently are also including buyside-to-buyside (consumer-to-consumer, or C2C) and participant-to-participant (P2P) functionality. Many retail and newer institutional platforms such as Liquidnet Vega-Chi jumped straight to P2P in an attempt to link buy-side to buy-side and correct the fixed income market liquidity imbalance.
One area for continued growth in electronic trading will be the repo/financing arena. With many banks questioning their repo operations, new systems will be necessary to better manage collateral and counterparty risk, and, most importantly, to allow for buyside firms to trade directly with one another. Much of this will play out over the next few years as banks and asset managers find ways to deal with new capital and regulatory requirements within the repo market.
With more than 25 fixed income EMS / OMS systems in the market place it actually causes more market fragmentation; not less. Another area in the electronic fixed income area that is gaining traction is aggregation. This aggregation can come in two forms execution/liquidity aggregation and trade information aggregation. Any system that can aggregate this data in one place will be front runner for any buyside system. TradingScreen is an EMS that does just that by consolidating data from multiple sources and providing a liquidity snapshot for traders. In the information aggregation space, fixed income solution provider Algomi will consolidate data on a specific bond inquiry across multiple data sources within a given firm and allow for a complete trading picture in terms of internal trade history, market axes, bond holders, account sales coverage, IM and email chatter and so on. Aggregation with be especially key for smaller buyside firms as they try to navigate the changing trade environment while not dedicating resources to multiple systems that may or may not pan out.
With the need for increased market access, compliance, regulatory, risk management, and systems, many vendors are putting a premium price on their services. As many firms try to streamline operations by using electronic trade and back office systems, this represents an issue for all capital markets groups but especially for smaller-budget firms. The main question for many of the new electronic venues and the broker / dealer investment in them is how they will handle any increase in market stress and volatility. During the recent global economic crisis, liquidity vanished off most electronic fixed income trading platforms and many times, markets quoted were far from reality and not executable. My fellow analysts at Aite Group donot see how this will change with any future surge in volatility. Indeed, the large market imbalance between bank capital and buy-side holdings will make it more pronounced, forcing traders on both sides of the market to return to multiple sources-phone, IM, and screens-for market color and execution.
Who will win out in the end? A lot will depend on participation from the buyside and sellside. If you are a high yield trading EMS, for example, you will need the largest buyside holders and underwriters of high yield debt in your system. Without the key players in any fixed income market, traders will be reluctant to use any systems and even when they do you only have one or two opportunities to show value and best execution.
If it fails then, and in all likelihood, the trader will never return.
John Mangano is an analyst with market research firm Aite Group
