Beyond Equities: Evolution Of Technology And Concepts Into Fixed Income And Currencies

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With Chris Rice, Global Head of Trading, State Street Global Advisors
How can concepts from equities evolve into other asset classes?
At State Street Global Advisors I head up a global trading team with desks in Boston, London, and Hong Kong. Our trading philosophy is based on one really basic concept – to trade in the best interest of our clients as efficiently as possible. This philosophy was a core tenet that drove us to bring our global desks onto one common technology platform, across regions and asset classes for equities, currency and fixed income.
The primary focus of our traders is on client and portfolio manager objectives and market context and designing a strategy to accomplish their goals.
There has been a vast change in the technology and regulatory environment over the last 15 years which has helped to decrease transaction costs in US equities, which we look at as an evolutionary model that could be applied to other asset classes.
How does this feed into technology?
We look at asset classes in terms of liquidity. The listed market is the most liquid asset class because of the market structure that has evolved over time. So we approach other asset classes similarly and if you’re in currencies, for example, you can create something similar to the concept of a virtual limit order book, simply by working with various vendors.
It is a bit more difficult within fixed income, but if you cut across the top and look at liquid instruments that are exchange traded or over the counter, a common approach would be to electronify them to the greatest extent possible. If you have the equivalent of a central limit order book for an exchange or virtual limit order book for currencies within fixed income, you create the potential for a whole universe of bonds to trade.
On credit in particular, there are very liquid corporate issues that will trade, but for every equity issue there can be hundreds of debt issues. For example, General Electric common stock is very liquid (daily average value traded is roughly $750MM USD) but their debt issues are very fragmented; you can’t think about trading the debt in the same way.
Generally electronification makes the following more possible on these markets:
• Improves transparency.
• Increases order control and execution.
Moving to the second tier of less liquid instruments: small cap equities, emerging markets currencies, high yield corporate bonds; price and size discovery isn’t going to necessarily happen in a screen-based way, or a virtual limit order books, or a central limit order book. You have to take a different approach by picking up the phone a bit more which takes more time but you have to get more creative.

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This then starts feeding into the technology and to the Order Management System (OMS), because the OMS is the control station for all the trader’s activity. The OMS allows you to build your strategy, but it also gives you a glimpse into the future. When you ask “What is possible within fixed income?”, even if you have a Request for Quote (RFQ) market, there may be other order deployment methods that could be created to push orders from a fragmented dark space into a more communal and transparent space for execution.
Because fixed income is not exchange traded, there are many order characteristics we’ve talked to dealers about in terms of gaining more insight to their inventories in a streamlined fashion using simple software which would allow them to present their inventory in a way that enables us to react and respond electronically, or at least to better understand the breadth and depth of it.
What is the progression across asset classes?
Greg Berman from the SEC likened the equity market to the operating system for an iPhone, and the apps that iOS handles as the instruments that go through the exchange of the iPhone. For non-equities, there is no iPhone equivalent – no central operating system or nerve centre. There’s over the counter for currency and over the counter for fixed income.
Currency appears to sit in the middle; if you’re thinking of G10 currencies where dealers can provide streaming prices into a virtual limit order book, currencies are actually the nearest cousin, if you will, to equities.
There is sufficient liquidity at a touch to virtualise and create a screen-based market because liquidity is there. When looking at topics around market structure challenges for equities, a lot of them relate to currencies: for example the high frequency presence or fill ratios. This “equity recipe” can then be integrated into currency in the same way, through electronification and equitisation.

“Currency appears to sit in the middle; if you’re thinking of G10 currencies where dealers can provide streaming prices into a virtual limit order book, currencies are actually the nearest cousin, if you will, to equities.”

We are trying to stay on top of that efficient frontier of electronification and to push that frontier out by being very active with market participants, with vendors, and also regulators, because a successful solution will rely on all of these groups. We have engaged in very productive dialogue with our regulators across regions on these topics.
How does this feed into conversations with the sell-side and vendors?
Everything we do at SSgA is technology-enabled and we have primarily taken a buy versus build approach. John Wysocki, our Head of Cash, Compliance, Fixed Income and Trading Technology and I are attached at the hip so we can realise our vision for technology and aggregation of liquidity. We have a strong foundation with our order management system, and have stayed with one vendor as we’ve expanded out into currency and fixed income. This is a global discussion within the firm; liquidity issues and secondary market liquidity are big challenges. Revolutionizing an industry that is nearly 150 years old will take time and teamwork.

Equities are highly electronic, so our conversations with vendors are more around fine tuning than re-engineering. In fixed income, we are very proactive in contemplating solutions that would not only benefit our clients, but the broader market.
A few years ago had a conversation with a start-up company as well as an established electronic trading provider and suggested they get in a room together. The vendor was working on a pricing methodology based on Bayes theorem, or ‘nearest cousin’ pricing. The idea was to take trading data from many sources and build curves on similar bonds and come up with a theoretical price of where they would be trading in the market.
State Street approached a well-established vendor in the electronic trading space which understands the surrounding challenges, and we asked them to apply their intellectual capital to create a solution to cross bonds. The plan never came to fruition due to various challenges and changes, but it’s a good example of how we’ve taken this out to the market to explore new ideas.
What’s different about our approach today is that we pursue electronification proactively and if we can play a role in engaging with our peers, vendors and other market participants to discuss ways to apply concepts from equities to fixed income, we will.
We are not the only firm pursuing this approach and over the last few years, buy-side and sell-side firms met and talked about a lot of these issues and worked on how to think through them more efficiently. And there were ideas of crossing and more efficient transmission of inventories. The result of this is that we are having more active and productive conversations. While the buy-side has been driving many conversations, the broker dealers are also being very proactive and the vendors want a partner. This is happening across all the asset classes, but in particular within fixed income.
How do these conversations vary across different regions?
SSgA has clients all over the world covered by multiple regulatory regimes, and you have to think about what kind of input they are giving at a regional level and how that informs your global strategy. What we try to do is identify how for liquid instruments, for equities, the rules in the US may be different to the UK or Europe or Hong Kong. In equities, 90% of our activity in the US happens electronically. And again, this is a function of asset composition.
I’d estimate that this percentage is 70% electronically in equities across the three regions. In some markets, electronic connectivity has matured or is in a different phase from a local market perspective and what a vendor can offer in terms of upgrades and tools to us.
What does the future hold?
At the end of the day, our primary goal is to get the best possible result for our clients. We have to constantly look at all markets going forward across asset classes and to push for the changes we think will create the most efficient markets possible.
We are constantly looking for examples of what works in fixed income, currency and equities and considering if there is an application in another asset class. We examine where we could take those conversations with vendors, market participants, regulators and exchanges into a new direction to make it more efficient.
The future holds many more of those conversations. We are also continuing to push that efficient frontier on electronification for central limit order books or virtual limit order books. It could also be that we work with other vendors to expand market access. Many of the trading protocols in fixed income are expanding to connect more efficiently.
What you’re going to see is market efficiency continuing to grow. The conversations so far are just the tip of what is possible and I believe the buy-side will continue to take a more active role in driving these discussions.
The pace of change will increase because of a much more engaged buy-side, sell-side and vendor community. The brokers in our market have also been very responsive and proactive in their approach. While there are many different views on how change will take place, the end result will require collaboration and technology.