Developing TCA For Fixed-Income
With Fabien Oreve, Global Head of Trading, Candriam Investors Group
In the equities world, Transaction Cost Analysis (TCA) is an important analytical tool which has expanded to FX and more recently to fixed-income. Nonetheless, there are many more challenges in fixed-income than there are in FX and equities. Three main factors explain this expansion to fixed-income. The first is the current economic policy of zero-interest rates. This has forced investors hunting for yields into a wider range of fixed-income instruments and less liquid securities; that has, subsequently, increased the need for post-trade analysis.
The second factor is regulation, the impact of which is being felt on both the sell-side and the buy-side. On the sell-side, the regulatory pressure on balance sheets means that asset managers have no choice but to diversify their access to liquidity and expand their broker lists, which include more specialised and regional banks. This, in turn, naturally means that investors need more analysis to understand who is doing what. The other aspect of regulation pressure is on buy-side. We are now seeing increasing numbers of reporting and transparency requests from portfolio managers and different departments, including compliance, risk management and auditing. The final reason for the expansion of TCA into fixed-income is technology: the growth of electronic trading, the integration of multi-dealer trading platforms into OMSs and the sophistication of those OMSs have greatly facilitated the processing of post-trade data.
The implementation of TCA is considerably more challenging in fixed-income than it is in equities. Fixed-income contains a far greater number of instruments and a far greater number of different types of instrument. On top of that, the publication of post-trade public data like TRACE in the US does not exist in Europe. Poor transparency is a challenge to post-trade analysis in fixed-income.
Fixed-income is further complicated by the complexity of categorising bonds as liquid or illiquid and the challenge of defining the appropriate thresholds of voice trading (vs electronic trading) across various categories of bond instruments. Building up a best-execution process that identifies when to trade electronically and when to adopt traditional methods (telephone or IB chats) requires not only a dialogue with compliance officers but also full and deep attention to portfolio managers’ opinions.
Another challenge is the execution benchmark. In order to evaluate best execution in fixed-income, each trade can be compared against the composite mid-“bid-ask” spread (the market mid-level) provided by multi-bank trading platforms at the point of execution. That said, in the case of illiquid bonds, comparisons are not always meaningful. The low number of market-makers in a given instrument at any given point in time can make the electronic composite price (that is normally made up of a large number of dealer pricing indications) irrelevant.
The final challenge we face is that far more trades are done over the telephone in fixed-income than in equities, especially in corporate bonds. In order to get the most reliable analysis for bond transactions and to input all those transactions into the TCA tool, you need discipline from the traders, who have to get all the post-trade data into the OMS as quickly as possible.
A truly multi-asset TCA
TCA is connected to all trading regardless of asset class. It is a tool that promises an effective best-execution process; it helps you analyse your trading activity, the costliest trades and the performances of brokers vs. execution benchmarks.
If you again compare asset classes, there is common ground between equity TCA and fixed-income TCA in the construction phase. The TCA construction process consists of extracting trade history from the OMS (which is the structural backbone for TCA), then combining that data with independent market pricing, sourced (in the case of fixed-income) from any of the multi-dealer platforms and (in the case of equities) from consolidated order books.
There is, however, a clear distinction between that construction phase and its finalisation. The second phase differs between bonds and equities because, with bonds, you have to determine and analyse more categories, more sub-categories and “liquidity buckets”. In equities, there are many more order types and execution benchmarks. Today, a TCA tool in equities compares trading results against different execution metrics (arrival price, VWAP, % of volume, etc.) across a limited number of categories while a TCA tool in fixed-income compares execution against a composite price across a wider range of categories and sub-categories.
Developing the system
A key consideration when developing a TCA system in fixed-income is to be aware of market structure and the role played by broker-dealers. The market structure in fixed-income is driven by principal trading, not agency trading, so the way bonds are traded is often “all or nothing”. The agency model will gradually progress in fixed-income but this will take time and we will need to keep a flexible model for trading much of our business.
That’s why an efficient post-trade analysis system in fixed-income should go beyond the cost aspect, display who your top counterparties or top liquidity providers are across various categories of instruments, help you trade better and find more liquidity. Liquidity discovery is the natural continuity of TCA in fixed-income. At the Candriam trading desk, we have incorporated a search engine connected to our trade history database into our TCA tool, so we can find our top five counterparties for specific instruments or segments. This tool has been designed to broaden any search and to select the issuer, so we can sometimes get five or ten different issues from the same issuer. This can include correlated or similar issues, and it is very important that the tool is able to give us that information.
TCA for fixed-income is quite a new area in Europe, so our preference initially has been to develop and test our own system. It has taken several months to construct our TCA tool, but it has not been a linear process. Traders have spent time working outside normal business hours and speaking with portfolio managers. The creation of a TCA tool not only gives us greater control, it also enables us to share appropriate solutions for end-users with our OMS provider and TCA vendors.
The long-term future of fixed-income TCA is closely related to OMS sophistication because today, the OMS is the backbone and, technologically speaking, it is becoming further advanced all the time. The OMS will become more integrated, further standardised and provide increased access to crucial areas such as pre-trade and post-trade functionality. It also involves cooperating with TCA vendors, who are developing peer-data and peer-group analysis.
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