With Paul Squires, Head of Trading, AXA Investment Managers Initiatives In Fixed Income
We are currently trading around 80% of our fixed income credit orders electronically with over 90% for government bond orders. They are executed through our OMS, which uses FIX connections to the RFQ platforms such as MarketAxess and TradeWeb, providing us with an STP environment. We have had this in place for a number of years which has become something of a norm across the buy-side that have the resources to put towards this kind of connectivity.
What is more significant to the fixed income trading market are the constraints that have been put on investment banks in the way they can use their balance sheets, due to regulation such as Basel III. This has an impact on liquidity and the quotes we get from those electronic platforms or the quotes we get by voice. They clearly don’t have as much balance sheet to use as they have in the past and that significantly constrains liquidity, or at least the capability to recycle inventory.
This is how we arrive at a situation whereby 10 percent of the fixed income bond universe which was historically “in play” at any one point between the buy-side and the sell-side, has shrunk to around 3 percent. The universe of instruments being recycled has diminished, and clearly the capability of banks to facilitate or intermediate between issuer names, different durations and different coupons has shrunk. While it is a little extreme to say so, it looks like we’re going to continue to move towards an agency model; you can see that the sell-side has become much more discerning in where they are providing their limited capital.
One of the general focuses, therefore, is not just on what might replace the intermediation that banks previously offered (and I think we have approximately 30 different vendor initiatives ongoing at the moment in various guises), but equally, to see if there’s a way to unpack more of that 97 percent of inventory that is very passive in the portfolios of investment managers. While it should be recognised that one of the fundamental differences between fixed income and equities is that a lot of fixed income instruments are bought to be held until maturity, this pursuit of increased liquidity should not be underestimated.
The buyside trader is traditionally quite passive in that the PM either holds dormant bonds or decides to make specific changes and sends orders to be executed. So between the two objectives of trying to release dormant bonds that rest passively in the portfolios and simply looking at liquidity when the trader receives an order to execute, is clearly some margin where there is some inventory the fund manager may look to recycle if they think they can improve yield, duration, exposure or anything else that might enhance performance and it’s that bit where there is a very interesting innovation at the moment. How you achieve that goal and which one of the numerous initiatives is going to be successful is the biggest unknown, but there is certainly increased optionality from, for example, the order book structure (BondMatch), crossing opportunities (Liquidnet) and variants thereof (for example Algomi), in addition to the RFQ approach, all to some extent an illustration of the new paradigm for fixed income trading.
The regulatory push
With the MiFID II ESMA level 1 text already delivered, I’m not sure how much more further regulatory change there will be. A key driver has been for heightened transparency which impacts our consideration of what will be required by 2017 on both pre- and post-trade. This has started to influence our thoughts around gathering a composite view of prices from multiple venues and banks (pre-trade) to how we could ‘smart order-route’ to secure the best execution for our clients based on those prices.
What are the FIX initiatives?
One of the recent developments we have benefitted from is the use of FIX to send fixed income OTC orders (CDS, IRS etc) to the RFQ platforms that support those instruments. This extends the scope of STP from the cash universe already mentioned with the connectivity provided by our EMS provider. On the same theme of mitigating operational risk, Adam Conn at Barings, as co-Head of the FIX Trading Community EMEA Investment Management Working Group, is leading the work on bringing FIX to the IPO/New Issue process. Also within the FIX Trading Community Sassan Danesh, who runs the fixed income stream within the FIX Trading Community, is very pivotal in that role in a wider sense and of course the FIX Trading Community is a community that involves the sell-side, buy-side, vendors and exchanges.
One of the things we’ve been talking about is the role FIX can play as a data standard, which might make execution between banks themselves easier, as well as enabling the buy-side to access more pools of liquidity. So the protocol is an element of what might allow all market participants to interact and from our perspective, deliver a solution that is platform agnostic.
So for example a trader acknowledges their order and is alerted if there is anything on a crossing network. The consolidated view of market prices not only gives pricing information to execute the crossing order but, if there is none, then forms the virtual book which will dictate the subsequent execution decision (potentially for example using an algo but equally useful if trading via voice). Electronically various filters could be applied according to your own preferences. We think such an approach lends itself to connectivity and therefore FIX data standards will be very useful to keep technology costs from spiralling.
The dialogue is very fluid. It’s very dependent on the buy-side and sell-side collaborating to take it to the next step because there’s certainly interest and Sassan is doing a great job at the hub of that exploration. Then we have seen some great prototype work from our EMS provider so we are very excited about the future market structure of fixed income trading but it needs a tangible commitment by stakeholders to really move it forward. That will be the acid test.