Summit: Fixed Income Needs Collaboration, Better—Not Faster—Tech

Over the two-day conference, heads of fixed-income trading from European buy-side and sell-side firms pondered the changes happening in the fixed-income space, and called for a better collaboration between the buy and sell side in order to gather the liquidity in one place. Better communication between the two desks, along with better technology tools, such as independent transaction cost analysis (TCA) and smart order routing (SOR), can help improve liquidity problems.

Liquidity in the fixed-income market has been drying up since 2008, and there has been a switch in that most inventory is now held by the buy side while the trading infrastructure remains largely operated by sell-side firms. For Gianluca Minieri, global head of trading at Pioneer Investment Management, the real question is whether the buy side and the sell side can work together for better dissemination of information and liquidity.

"There are a number of initiatives that have been launched with a majority of buy-side firms and a handful of sell-side firms to look at how we can push for more common leverage and improve connectivity and technology between those actors," he says. "We should use innovations in technology to try and build a sort of aggregation tool that can create new sources of liquidity for the fixed income market."

More Liquidity, More Automation
The challenge, explains Jonathan Gray, head of fixed income at US-based dark pool operator Liquidnet, is to draw in liquidity in one place—and technology can do that.

"What we need in the future is some sort of mechanism to wake up the dormant liquidity," says Erik Tham, head of fixed income, electronic order execution desk, at UBS Wealth Management. "There has been a lot of work and consolidation around the central order book but you need a certain amount of liquidity and a certain frequency of trading. Otherwise, it doesn't work. We are at a time when something new needs to emerge but the big question is which platform will enable that."

"Electronic trading does not create liquidity. It helps finding liquidity but it does not bring new forms of liquidity into the market, which is essentially what the market would need," says Callaghan.

For buy-side participants, there clearly have been a lot of efforts made toward the electronification of the fixed-income market, but electronic trading is not the answer for all the issues it is facing.

"Electronic trading does not create liquidity," says Elizabeth Callaghan, an independent consultant who works in regulatory and market structure strategy. "It helps finding liquidity, but it does not bring new forms of liquidity into the market, which is essentially what the market would need."

Minieri says that although many buy-side firms are investing a lot of money in order management systems (OMSs) and execution management systems (EMSs), it is also important not to become as obsessed with speed as the equity market can be, because technology can't really help with a bond that get traded once every six months. "The technology in fixed-income markets should be aimed at creating and facilitating natural flows. We don't aim to build a strong and fast technology platform," he says.

A Change in Market Structure
On the sell side, challenges are different. "As our margins are decreasing we need more automation," says Mario Muth, global head of rates etrading sales at Deutsche Bank. "Having a human in the middle of a process while you are trying to make it  transparent and fast is very challenging. It's the market as a whole that needs to be better committed to electronic trading, not just the sell side."

For Muth, request-for-quote (RFQ) models will remain, as they are the best way to transition from a voice model to an electronic one. But other panelists on the buy-side criticized the effectiveness of this model, which has appeared to be very limited, especially in recent years. "It is hard to believe in a model where firms are allowed to publish prices that they are unwilling to trade—it simply isn't working," says Minieri. "We need to push for more reliability of prices."

The ongoing transition in the fixed-income market toward an openly accessible and executable marketplace is, according to the panelists, putting pressure on market-makers who will find it harder to know what their risk exposure looks like. They might react by widening their spreads or might even end up stepping away from that market altogether. This will concentrate the market-making activity on the most liquid bonds only, creating even more discrepancies and fragmentation in the market.

Although some argue that regulations have pushed the transformation toward an equities-like market structure for fixed income, for Callaghan, the market is simply undergoing a natural cyclical change.

"We are not witnessing an equitization of fixed-income, but rather a standardization of the market structure," says Callaghan. She says the evolution in the fixed-income space will be technology-driven but this does not necessarily mean it will only be through electronification and equitization.

Bottom line:

• Heads of fixed-income trading from European buy-side and sell-side firms are calling for better collaboration between the buy and sell side in order to gather the liquidity in one place.
• Buy-side participants say there has been a lot of effort made toward the electronification of the fixed income market but that electronic trading is not the answer for all the issues the fixed-income space is facing.
• The technology in fixed-income markets should be aimed at creating and facilitating natural flows, not building platforms for speed, as is done in the equity markets.