Fixed Income transparency is taking centre stage in Europe
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24 February 2012Joséphine de Chazournes
Two weeks ago at the Afme (Association for Financial Markets in Europe) conference in London, Fixed Income finally took centre stage! After years of talking about Equities, ATS then MTF, the rise and fall of hedge funds, high frequency trading and MiFID, maybe a little help from the financial crisis and thereafter (or was it before?) from regulators with MiFID2, Basel3, Solvency2 and the proposed Volcker rule there is finally enough meat on the table to have a full meal, even for our great financial champions. Extremely high quality of speakers, extremely high quality of panels, extremely high quality of attendance, but what struck me most was that we have to watch this space: competition could be heating up… It all started in 2010 when the Cassiopeia Committee, supported by the French ministry of Finance and Economy, sent out an open request for information (why not a request for proposal?) for an electronic institutional European corporate bond trading MTF, together with a set of extremely detailed guidelines on how to do it best according to them, including an all-to-all platform (meaning open to buy and sell-side members), order-book and CCP. Three proposals for new projects were made, one by NyseEuronext, one by MTS, and one by TradingScreen (another one, they realised, already existed for retail, EuroTLX) and there was no winner because this was not a competition. In Italy, when MiFID was transposed by legislative decree into Italian law, the way Fixed Income assets became traded was no different than the way Equities were traded. In fact, now Italian retail liquidity in Fixed Income is fragmented between one exchange (Borsa Italiana), four MTFs (amongst which EuroTLX) and seventeen internalizers. And to guarantee best execution in Fixed Income some Italian brokers route orders to the venue where liquidity and the best price are and enable asset managers to rebalance their portfolios through DMA systems. Of course this is not institutional flow, it is retail (roughly €50k). It probably is impossible to see such a model being extended to institutional sizes. In European Fixed Income historically most institutional trades were done over-the-counter with a bilateral agreement. There was no order-book, no clearing house, not even commissions, banks still today get paid with a piece of the bid-ask spread they quote to the buy-side. How could you expect a Fixed Income trader to price €50k or €20M with the same spread since if they do not get paid a commission proportional to the size of the trade? But transparency is a goal many European asset managers are aiming for and if they already get some pre and/or post-trade data from brokers or electronic platforms such as MarketAxess, or Tradeweb, there is no consolidated tape or TRACE-like data in Europe yet. Hopefully regulators will find a public or private provider for a European Tape, and MiFID2 will impose new and more stringent reporting rules that will not hinder liquidity or reduce trade sizes as some argue. Liquidity is also not comparable between Equities and Fixed Income: there are many more securities (just think of the Nestlé stock just being one and its numerous sister bonds with many different structures, coupons and maturities) and only 3-5% of them are actually liquid. Typically they trade right after the issuance, but then die away, except for unforeseen events such as downgrades. We have seen a lot of these recently in European govies but it has also meant that European corporate bonds’ liquidity has dried up. Will this change with MiFID2? To me the fact that some of the new electronic institutional fixed income platforms have pricings based on commissions and order-books is a clear push towards transparency. It looks like current market players are also preparing for MiFID2. Bloomberg for example, could in time become an OTF with firm prices for the buy-side; Vega-Chi, will be offering not only convertible bonds but also financials and high yield European bonds to the buy-side; UBS PIN-FI, already offers a wholesale platform for the buy-side with firm prices next to its retail odd-lot business. How many more of these projects are in the pipeline? The story does not say however how, post MiFID2, buy or sell-side firms will have to go through the headache of having to decide to which platform they are going to have to link up to guarantee best execution to a pension fund or insurance client, and how to integrate it best with risk management systems, and how much it will cost in terms of resources and money... We all know how much traders like to work on such operational projects, let alone the traders of the asset managers… And… Did I mention that most of these traders do not have an order management system (OMS) or execution management system (EMS) to route liquidity to the best platforms or trading venues? Because, remember, this is not Equity, it’s Fixed Income, traders actually do have to stream liquidity themselves because rarely here do they find firm orders, they're mostly looking at Requests for Quotes (RFQs) that still have to be negotiated. I think I have a topic for my next research… To be continued!