Alex Struc, Portfolio Manager, PIMCO Source, photo courtesy of AFME
Electronic trading is maturing in fixed income, providing the kind of increased liquidity and transparency essential to developing algos. It's also given rise to a cottage industry of initiatives geared to attracting the buy side onto platforms, and perhaps more controversially, into giving up their trade information.
Alex Struc, portfolio manager at PIMCO, who also sits on the firm's best execution committee, said that what's needed is firm order posting, which is what kicked off the equity market.
"The data providers who have firm access to the orders from the buy side community, and with the defensive and secure trading protocol will eventually win," he said.
Struc was speaking on a panel at the European Market Liquidity Conference, hosted by AFME (Association for Financial Markets in Europe), and struck a cautionary tone to the burgeoning platform provider environment at the moment.
"I don't see a space for two or three or five different models. I see a space for one that is combining all the others," he said, adding that another differentiator is about getting access to orders and not just trading protocol.
"Trading protocol we can figure out among ourselves. But it is people who have the captive audience, and so far we have two strongest, and three in total, providers who have access to investors orders, who are posting actively and saying I am ready to do that. Both platforms have been gaining critical mass," he said. PIMCO declined to provide further details.
Some commentators note that there are a lot of legacy practices in fixed income that suit the status quo. "You just have to look at the P&L of an investment bank over the last 20 years and you will see how much money they have made out of fixed income. And why do you want to change practices of a very profitable business?" said a senior executive from a financial services firm.
For now, the growth of algorithmic trading is restricted to certain products within the asset class, namely the liquid rates products such as listed derivatives - Treasury futures, short-term interest rate futures - as well as Treasuries.
Sassan Danesh, co-chair of the FIX Trading Community Global Fixed Income sub-committee, and managing partner at Etrading Software, said that one area of interest to watch over the next few years is the potential growth of swap futures, which lends itself to algo trading. The others are vanilla benchmark swaps and CDS indices.
Aside from the increased maturity and transparency, other factors boosting the trend is that it's getting easier to acquire datasets for backtesting, and many firms are deploying cross-asset algo trading platforms that they are then customising for the fixed income markets.
FI traders are now using or considering the use of algos because low touch algo trading is getting more attractive in an environment where increased costs from regulation, such as Basel III, results in continued margin compression.
Additionally, algo traders from equities, and futures and options now see an opportunity to leverage their existing investments in FI.
But there are yet obstacles. "Much of the market is still OTC and opaque, with the lit markets not providing sufficient depth or liquidity to provide a meaningful representation of actual prices for institutional size trades," said Danesh.
Also, the characteristics of the FI market is itself a barrier.
"The much larger and diverse universe of FI instruments, many of them illiquid and rarely traded, is less suited to the exchange/central matching paradigm that is a 'best fit' for algo trading," he said.
Danesh has been involved in bringing greater transparency and efficiency into the fixed income OTC markets by facilitating collaboration between the broker-dealer community and execution venues to define industry best practices using the FIX Protocol for trading OTC bonds and derivatives.
He noted that post-trade transparency is lacking in Europe in comparison to the US. That's because Europe doesn't have TRACE (Trade Reporting and Compliance Engine), which was introduced in 2002 in the US to increase price transparency in the US corporate debt market.