Changing Of The Guard: Fixed Income Electronic Trading

Stephen Gallagher Jr.   13-August-2017

It is very clear that electronic trading in the fixed income markets is advancing exponentially creating more efficiencies for market participants, improving liquidity, and reducing market segmentation.  As liquidity and transparency problems continue in the fixed income space, electronic trading continues to grow and you will see many venues consolidating while the four dominant players in the arena (Bloomberg, MarketAxess, Tradeweb, Liquidnet) continue to grow and offer more tools for the buy side execution trader. 

Reducing the dependence of the traditional voice trader/ salesperson relationship and becoming more dependent on electronic trading generates lowers transaction costs, provides better liquidity, and creates a greater variety of opportunities to trade a portfolio. The dealer-client relationship will still exist particularly for illiquid; price and size sensitive positions. Traditionally when a client wishing to trade a specific security would contact several dealers via phone asking for available prices; buy side clients did not communicate nor trade with other buy-side market participants.

This is changing through the inception of all-to-all trading capabilities now provided by all the major ECN’s (Electronic Trading Networks).  All-to all ECN trading is changing the behavior of buy-side investors. Buy-side firms now have the opportunity to act as price makers rather than price takers from the dealers. To be clear, buy-side firms have not become market makers. Rather, they are participating in the market directly as buyers and sellers more regularly.

  • It is estimated that 5% of electronically traded US issued IG and HY corporate bonds was traded on all-to-all platforms last quarter and this continues to grow. All-to-all platforms have seen tremendous growth in Europe and this will soon evolve in the US markets. 
  • MarketAxess reported that their platform booked record volumes in the first quarter of this year. The company’s global clients traded $944 million of European fixed income products through its all-to-all system, up 140% from the previous quarter.
  • Since launching in September of 2015, Liquidnet’s all-to-all fixed-income platform has increased to $7 billion of order flow per day. In January of this year, it had more than 230 different institutional firms and more than 165 users.

There has been growing focus by large buy-side on locating new sources of liquidity as regulators are increasingly demanding proof of best price execution through TCA (Trade Cost Analysis). Very few fixed income buy-side firms know the true details of their transaction costs. The exact transaction cost incurred and TCA (fees, commissions, dealer makeups, intra-day market movement) is a difficult figure to calculate given the trading dynamic of the fixed income market. 

Other non-ECN technological innovations have been introduced into the marketplace in Europe that will soon take grip in the US markets. This includes platforms that uses technology to increase the chance of matching two participants in the fixed income market with offsetting interests.

There is a lot of excitement on the street surrounding companies such as Algomi and Neptune.  Algomi is a non-ECN platform that provides market information on liquidity and opens the window to real-time activity into the markets, including: governments, corporates, emerging markets, municipals and structured credits. It uses algorithms to link groups of dealer salespeople offerings, dealer Axes, ECN’s, and other buy-side client inquiries and inventories to generate trade ideas and consolidates all this information into one location. Due to market’s segmentation, quotes and pricing for the same bond at the same time can vary greatly across dealers and ECN’s. Algomi solves this problem. This utility helps traders and portfolio managers determine not only whether to buy or sell a security given current market conditions, but also how and which platform to execute (Electronically or through a dealer salesperson). Algomi aims to add more US dealers and buy-side clients on top of the 80-plus US asset managers already on the network. With broad access to streams, runs, inventory, and axes in one place, Algomi aims to augment and streamline the trader’s workflow, create new trading opportunities, and enhance price discovery and minimize operational costs.

Another innovation is starting to solidify a footing in the corporate bond space is Neptune. This network provides buy-side firms high quality axes, pricing and inventory data from most of the dealers. This allows traders and portfolio managers to be more effective and targeted when looking to execute large size orders. Twenty one dealers are already live on the network, providing axe information in real-time on over 15,000 different securities with over $150 billion in gross notional across 20 different denominations. This is generated from over 27,500 pre-trade real-time “axe” indications in the network, daily.  

The electronic trading environment is primed for continued growth as market participants access more information with better analytics to support their trading activity. By taking advantage of these technological advancements and devising new methods of trading, buy-side firms are able to have broader access to markets and their participants. Ultimately this will increase transparency, uniform a trader’s workload and reduce operational costs, and enhance performance. There no better time to capitalize on these developments.