Regulators may be pushing bonds onto electronic trading but this does not signal the end of voice trading. Lynn Strongin Dodds finds the two are likely to happily co-exist for the foreseeable future.
It was only a matter of time but the announcement that the CME Group was closing most of its trading pits in New York and Chicago still provoked an outcry of nostalgia. It has taken longer than expected for electronic trading to permeate the bond markets but they are increasingly making their presence known. The last two years has seen a swathe of platforms launched while many are waiting in the wings but few believe that will be the demise of the human touch.
This is particularly true with the thornier more difficult instruments such as large OTC trades or complex structured products which lend themselves to voice trading. Although it varies by instrument corporate bonds are still dominated by the banks with around 60% of business conducted over the phone. Traders are also more likely to go ‘old school’ during times of market stress which was evidenced this year when Bloomberg’s 325,000 terminals suddenly suffered a blackout in April and the Swiss government unexpectedly unpegged the franc cap it put in place since 2011. Both events wreaked havoc on the markets.
As David Clark, chairman of the Wholesale Markets Brokers’ Association, notes, “Although the G20 recommendations place greater emphasis on electronic trading, voice trading will not disappear. One only needs to look at what happened when the Bloomberg terminals shut down and the Swiss government abolished the Swiss franc//euro floor, when everyone reached for the phone. In that context, voice trading was used as a back-up. In stressed circumstances, market participants will also want to speak to someone to get market colour and information. What we will see is the continued migration towards electronic trading for the more commoditised and standardised products.”
Clark also notes that there is a place for voice under MiFID II, which has proposed that an organised trading facility (OTF) can engage in voice, electronic or a combination of the two. This is in contrast to the US where swap execution facilities (SEFs) can only offer electronic, “There is a tendency for people to confuse platforms and venues because they both offer electronic trading. However, although we are not sure what the OTFs will eventually look like, they are expected to cover both voice and electronic trading,” he adds.
“The reality is that it’s always going to be a continuum of liquidity provision and negotiation mechanisms. Voice and electronic are very much complementary, so when everything is fine, there is limited volatility in the market and no disruptions, then electronic trading is a good way to churn a large number of tickets. However, when you need a little bit more of discretion, whether it’s on price, quantity, or the counterparty you’re dealing with, you always come back to voice. So, it’s always a balance between the two.” – Fred Ponzo, Greyspark Partners
Other market participants also believe the two can happily co-exist. “There is a misconception that one has to replace the other but that is not the case,” says Fred Ponzo, managing partner at consultancy Greyspark Partners. “The reality is that it’s always going to be a continuum of liquidity provision and negotiation mechanisms. Voice and electronic are very much complementary, so when everything is fine, there is limited volatility in the market and no disruptions, then electronic trading is a good way to churn a large number of tickets. However, when you need a little bit more of discretion, whether it’s on price, quantity, or the counterparty you’re dealing with, you always come back to voice. So, it’s always a balance between the two.”
Michael Cooper, CTO BT Radianz services, at BT, also sees the hybrid model evolving to incorporate the two forms of trading. “I think the demise of voice trading is greatly exaggerated. Even over the long term it will not be eradicated because it is an important part of the trade cycle and traders will always need to talk to each other and collaborate. It is possible, however, that the amount of business conducted by voice will decrease over time.”
There is no shortage of players looking to make their mark in the electronic space, particularly in the thinly traded $7.8 trillion corporate bond market. “The electronic trading model in the fixed income world is in play, and the race is on to redefine the historic paradigm,” says Russell Dinnage, senior consultant in the capital markets intelligence practice at GreySpark, who co-wrote the recent report – Rebooting the Corporate Bond Market — with Ponzo. “We are seeing a collection of technology vendors, exchange-like platforms and exchanges that are trying to create new market structures that both the buy side and the sell side can participate in. This effort is being made by the industry in response to the shrinking of bank balance sheets following the implementation of Basel III.”
Industry figures show that the amount of corporate bonds held on dealer balance sheets has dwindled dramatically by 76% from a record $235bn in late 2007 to just $56bn currently at the end of last year. However, the top 20 players are tightening their grip, accounting for 82.6% of the annual corporate bonds turnover in the US and 84.8% in Europe, according to the Greyspark report.
Ponzo notes that at the last count, there were 80 bond trading platforms jockeying for position. Some are trying to wrest control from the banks by cutting them out of the picture or reducing them to an agency role, although they will still have to rely on them to help with price formation. Others aim to keep the broker dealers in the loop and help them do more with less. In other words, reconstitute in a synthetic way the large costly inventories they can no longer afford and optimise the deployment of their capital to the benefit of their key clients.
Of course, the road to success will not be easy and side-stepping the banks may not be a winning formula. Greyspark predicts that the majority of the 33 live corporate bond electronic platforms, and the eight due to launch, will have failed in three years’ time. The report notes that to date, “none of the proposed trading solutions can demonstrate their viability without the active involvement of broker-dealers. In 2015, the role of banks in the corporate bonds market appears irreplaceable when it comes to managing the time mismatch between buyers and sellers, or to generating fair and tradable prices.”
However, as with any new trend, some initiatives generate more buzz than others. This is particularly true with Bondcube, which is minority owned by Deutsche Börse and offers an all-to-all platform that takes anonymous indications of interest from both buy side and sell side firms, allowing each to list securities, trading size boundaries and directions. These indications are then matched and opened to negotiation between counterparties.
TruMid Financial, which boasts senior fixed income specialists from Goldman Sachs, Barclays and Citadel, has also created a stir with its so called ‘swarms’ .Each one will eventually include just 51 bonds in a mix of investment grade, junk and distressed debt. They will be divided into thirds – sector based, topical, with the securities chosen by the firm’s traders and bonds nominated by clients.
The other new kid on the block, Electronifie, which was founded by Amar Kuchinad, a former Goldman Sach trader and Securities and Exchange Commission adviser, is taking a different approach. The firm has lured big banks to provide continuous, firm quotes on about 1,300 bonds through a revenue sharing agreement, but it provides the anonymity that many big asset managers require.
These fledgling firms will not only face stiff competition from each other but also from existing incumbents such as MarketAxess, Tradeweb and Bloomberg as well as equity players such as ITG and Liquidnet who are encroaching on their territory with their own fixed income offerings. This is not even mentioning the European exchanges who are striking partnerships such as MTS, the London Stock Exchange’s fixed income trading business and B2SCAN, a French platform who are pooling their efforts to makes it easier for asset managers to search for a particular bond, or list of bonds, and then electronically execute their trades on MTS BondVision.
The classic voice trading end of the market is also seeing its fair share of new innovation, For example, SIX Group recently debuted its own secondary bond trading platform for corporate bonds, targeting illiquid issues of at least €2m in size. It is using technology firm Algomi to provide information on dealer’s bond inventories. Launched by three former UBS executives in 2012, Algomi enables banks to keep a better track of the bonds they buy and sell and create a social network that details market interest in inventory.
“We don’t see ourselves as an electronic platform, inasmuch that we don’t do electronic execution,” says chief executive and co-founder Stu Taylor. “What we do is digitise the data and the workflow, but we then allow the individuals concerned, who maybe had connections made for them, to essentially get the trade done in whatever way they see fit. This can be over the phone or over a chat mechanism etc. I think this plays to the less liquid part of the market and the bifurcation that is taking place where you have a liquid component and a much less liquid component sitting side by side using very different execution mechanisms.”
Hear more about how both electronic and voice trading are evolving amidst new market change including regulation in a recent DerivSource podcast. Greyspark’s Fred Ponzo and Algomi’s Stu Taylor weigh in. You can listen to the podcast on DerivSource.com our App or via iTunes.
