Are there still fundamental differences between asset classes that make it impossible to trade them on a single, integrated trading network?
Over the last 20 years, derivatives have progressively reduced price dissimilarities and now efficiently connect many once-disparate markets. These derivatives have introduced improved price efficiency through arbitrage and relative-value trading. They have also demonstrated that a more-integrated trading world is both possible and extremely valuable. Could electronic trading achieve the same across asset classes?
It is true that trading models and settlement differences have kept convergence at bay and specialization preeminent. However, the evolution of technology, and the never-ending capacity to improve the speed of calculation and transmission, has already mostly cleared the way for unified trading.
Today, those improved efficiencies apply to foreign exchange, listed derivatives and equities. The two holdouts are fixed income and over-the-counter (OTC) derivatives. However, this is on track to change soon with the implementation of new regulations.
The recent emergence of cleared derivatives could help integrate these asset classes -- which have their own specific, complex workflows that make them difficult to merge with the efficiency of listed product trading and clearing.
So, why are fixed income and OTC derivatives the slowest horses across the finish line in the unified trading race? The reasons are conservatism and liquidity.
Rewarding Opaque Markets? Conservatism arises in markets that reward buy-side and sell-side actors for delivering an opaque market. In other words, there are many firms whose bread and butter come from the inefficiency of the market. These individuals are, understandably, not very responsive to new ideas that will eventually resolve the liquidity issue for the investor.
The banks used to play the "provider of liquidity" function. However, with the advent of the new capital rules and reduced appetite by the investor for risk, these functions have been phased out. Now, banks are no longer serving as market-makers. This has led to an explosion in the growth of bank fixed income platforms, with buy-side firms pressuring banks to somehow replace the liquidity that has evaporated.
To be sure, there is also a belief that liquidity issues in fixed income and OTC derivatives are just too different from what traders deal with in more liquid markets. It is to be noted this was historically the same argument presented for EVERY security that has already moved to a unified trading model.
In any case, these arguments are quickly becoming academic, as recent regulatory and market changes have made the current, comfortable way of doing business untenable.
It is our belief at TradingScreen that the liquidity issues of all security types are fundamentally the same, and can be resolved with similar solutions. This has been the vision of the company from its inception, and we are seeing this vision developing now.
Fixed income's slow but steady migration towards effective electronic trading and away from an RFQ-disclosed market shows that the market is on the verge of a major discovery: Fixed income liquidity can be collected and processed in an efficient and transparent way, while avoiding market impact just like what happens in other asset classes.
It is true that in all asset classes there are niches of deep liquidity and niches of scarce liquidity. Still, these challenges are already being resolved with technology in certain instruments and, eventually, will be resolved in all asset classes.
In the future, differences in trading systems won't be about different asset classes. It will be about differences in liquidity availability.