In our previous Insight covering the key themes at the 2019 Fixed Income Leaders Summit (FILS), we highlighted how electronic trading has grown in sophistication, and how trade automation is now a requirement for asset managers needing to construct, de-risk or rebalance complex institutional portfolios.
Underpinning the trade automation evolution is the expanding ecosystem of liquidity venues, broker-dealers, and an increasing number of non-traditional liquidity providers including buy-side firms. Technology vendors play a pivotal role here by providing the networks and solutions that help facilitate connectivity, price discovery and intelligent trade execution. This rapidly changing ecosystem was another key topic of conversation at FILS.
Much like their counterparts in the natural world, financial ecosystems enable mutually beneficial relationships between producers, consumers and facilitators. They are also prone to periods of rapid and disruptive environmental change, and mastering adaptation to new conditions determines survival or extinction. The global fixed income ecosystem currently finds itself in an environment of mounting supra-national regulatory obligations, the looming retirement of LIBOR, and persistently low interest rates that have driven record corporate and sovereign debt issuance. Counteracting those headwinds is non-stop technological innovation, most notably the ability to intelligently leverage massive volumes of structured and unstructured data.
With over 150 fixed income liquidity venues now operational, mergers, acquisitions and closures are happening with increasing frequency as newcomers fail to build critical mass, or established players realize greater synergies by merging with former competitors. The sheer number of venues speaks to the broad diversity of fixed income instruments traded across global capital markets, including sovereigns, corporates, high yield, agencies, munis and multiple OTC and exchange traded derivatives.
Few venues come close to supporting the entire spectrum of fixed income asset classes and geographies, and many were designed to support a particular asset class (like off-the-run-treasuries) in order to leverage asset-specific nuances such as liquidity, geography, regulatory and market structures.
Despite high entry costs and the considerable risk of not attaining viability in fragmented fixed income markets, liquidity venues continue to launch. According to Audrey Blater, analyst at Aite Group, “The ever-expanding number of electronic bond trading venues is expected to grow, with entrants able to offer more automated trading options, and developing new methods to foster liquidity, automation and efficiency.”
Broker-dealers have arguably undergone the greatest transformation post-crisis. Their traditional role in the ecosystem – providing liquidity to buy-side clients by warehousing inventory – was curtailed by regulation and shrinking balance sheets. Dealer assets peaked at $5 trillion in early 2008, contracting sharply to $3.5 later that year and now stand at $3.0 trillion.
Tim Keenan, Fixed Income Strategist at BondLend, explains that “dealers have had to pare down the counterparties they deal with and reprice the business they transact to reflect the new regulations, the ballooning cost of balance sheet and the encroachment of Fed programs. Anecdotally, many dealers have seen substantial increases in P/L in recent years, which shows that they were able to put on profitable trades with the clients that they remained willing to deal with.”
Interestingly, the shifting landscape has created opportunities for non-traditional fixed income players to serve as liquidity providers.
For example, an increasing number of regional dealers and inter-dealer brokers (IDBs) such as Tradeweb’s Dealerweb and TP-ICAP are now offering liquidity to the buy-side.
Anna Shtromberg and Kevin Molloy at ViableMkts state that “a buy-side firm’s tolerance for execution risk is a direct function of time. Those institutions that have enough time on their side to patiently wait to trade, can fully adopt price making as a part of their long-term trading strategy. Endowments, hedge funds, prop-trading firms and certain types of insurance companies are generally not required to provide immediate liquidity to the investors they represent. These types of buy-side institutions have an edge in price making capabilities because of their inherently high tolerance for execution risk.”
“With the buy-side holding more and more fixed income securities, they are now positioned to help improve market liquidity and increase secondary turnover. Holding the assets is not enough – the buy-side needs the appropriate technology, reach and skillset to move into a world where they are potentially competing with their traditional liquidity providers.”
Gareth Coltman, MarketAxess
The Rise of the Buyside as Price Maker
Shtromberg and Molloy detail 3 key requirements buy-side firms require to attain an edge from price making, including aggregation and organization of pricing data, the ability to manage incoming electronic inquiry from All-to-All RFQ platforms and ECNs, and technology for broadcasting their orders and resting prices across multiple venues.
Technology vendors have likewise undergone disruptive changes in a short period of time. Significant resources are required to develop and support innovative technology solutions in rapidly changing global capital markets, and the ability to fund R&D largely separates winners from losers.
Charles River has long served as an ecosystem facilitator, from the launch of our global FIX network and combined order and execution management system (OEMS), and most recently providing traders with aggregated, venue-agnostic inventory across multiple fixed income asset classes and geographies. Trade facilitation has been further enhanced with a suite of OEMS-based analytics for identifying rich/cheap securities and execution analysis to support growing regulatory reporting requirements, such as MiFID II.
The realignment of fixed income markets post-2008 has been remarkable, with buy- and sell-side firms taking on new roles, supplemented by startup liquidity venues and rapidly changing technology. The ability to efficiently facilitate trade given record corporate and sovereign debt issuance over that period underscores how well the global fixed income ecosystem has adapted to new market realities.
The build-out of Charles River’s fixed income trading capabilities over that period has helped buy-side clients adapt to an environment of leaner operating models, more fragmented liquidity, and significant new regulation.
The evolution of fixed income trading continues apace, driven by the emergence of new liquidity providers, shifting business models and non-stop technological innovation. Venues, brokers, buy-side firms, and technology vendors must continue to adapt in order to survive and thrive, while in turn helping ensure the overall health and viability of this vital financial ecosystem.
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