The Gateway to Algorithmic and Automated Trading

Fast-tracking the e-evolution of fixed income

Published in Automated Trader Magazine Issue 12 Q1 2009

Agility and visibility are essential in today’s turbulent and fragmented market, says Oliver Estenfeld, Head of Business Development, icubic. That goes for fixed income as well as equities and FX.

Oliver EstenfeldAs the financial crisis continues, banks' fixed income operations continue to face the double challenge of staying abreast of market developments and addressing the reducing liquidity. They're not alone in this, of course, but until recently, they have been largely doing it "by hand". While e-trading is well established in the FX and equities markets, fixed income e-trading still has some way to go before reaching maturity.

Just as the equities and FX markets' adoption of e-trading was seen as an evolutionary process taking place over time, so the fixed-income market is seen as having further potentially time-consuming transformations to navigate as it reaches its maturity both in terms of breadth and depth. But in other markets, electronic trading has proved to play a pivotal role in enabling banks to meet customers' demands and stay ahead of their competition - and thus, now, to stay ahead of the crisis. Consequently it is essential that banks look again at the trading methodologies of their fixed income operations to ensure both their survival and their strategic positioning in the increasingly turbulent economy.

The transition may transform the competitive landscape. The past decade's significant shift from voice broking and inter-bank dealing to the electronic markets across the major asset classes faced traders with an increasingly fragmented market and the continuous search for market depth and liquidity. For the smaller firms in fixed income, one challenge has always been that liquidity has been restricted to the larger players who had greater access and visibility of the markets. This allowed them to maximise trading volumes and meet their customer requirements with greater ease than their smaller rivals.

But with the adoption of e-trading in fixed income and the ramifications of the turbulent market place, the landscape may be levelling. Larger players no longer have the assured visibility, and consequent competitive advantage. Now the only way to guarantee success is to ensure that effective strategies, which provide visibility and agility, are developed and deployed into the markets. As a result, all firms potentially have equal chance of succeeding, meaning that the race is on to deploy the most effective approach to capture trading opportunities.

When discussing effective strategies for the move to electonic trading in fixed income, it is pertinent to separate the fixed income arena into two distinct areas; the inter-dealer markets and the dealer-to-customer markets.

In the inter-dealer markets, much like any other space, banks must be able to spot and react to liquidity faster than their competitive counterparts. However, while issuers once insisted on having liquidity solely on the MTS exchange, the move to broker platforms such as BrokerTec and eSpeed has driven the need for traders to view virtual market depth across multiple liquidity pools.

Banks need to find volumes at the best price and consequently require a complete and single view of the market in order to capitalise on this liquidity ahead of the competition. If banks' own systems are unable to cope with this challenge, as is often the case, they are likely to miss out on trading volumes through poor quote and order management.

In the dealer-to-customer markets, banks must also cope with a proliferation of electronic channels, including TradeWeb, MarketAxess, BondVision and Bloomberg. In the current environment, banks are under even more pressure to provide consistently high levels of customer service. Customers expect banks to handle RFQs and RFOs across multiple markets and asset classes such as the FX markets, including FXall, Currenex and 360T, effectively and at increasingly rapid speeds. As a result the choice between multi- and single-dealer portals continues to escalate.

Market fragmentation in this space is largely due to the fact that banks are charged to provide liquidity to other platforms. Consequently banks increasingly want to operate their own platforms, leading to a vast choice of single-dealer portals. While this prevents banks from being charged by other platforms, this action leaves banks and their customers vulnerable to technical glitches which could disrupt their entire order flow.

Furthermore, single-bank portals are often not cost-effective to maintain, since reduced platform charges rarely outweigh operational costs. They also provide less transparency, asking just one dealer for a quote, compared to the multi-dealer platforms such as TradeWeb which facilitate a RFQ model across several parties. Over 2,000 institutions and 35 dealers provide liquidity on TradeWeb, meaning that several dealers are notified when an RFQ is produced.

Many would argue that banks should avoid the single portal strategy, and play on their strengths. Access to multiple electronic channels allows banks to deliver increasingly competitive rates and liquidity while their clients can benefit from a single point of access to liquidity from a vast selection of institutions. With liquidity-takers keen to have visibility of their counterparties, this fully disclosed model puts the multi-dealer approach in a stronger position to succeed.

Banks need to ensure that they benefit from using multiple platforms and, despite its slow uptake, the move to electronic trading in fixed income is a key enabler to ensure banks remain competitive. To both survive and succeed in today's unpredictable market, fixed income operations need to ensure they have access to a multitude of electronic channels. Whether trading inter-dealer or dealer-to-customer, visibility and agility for both banks and their customers are crucial to overcoming the hurdle of decreasing liquidity in the increasingly fragmented trading environment.