Five years ago, while electronic trading was already the norm in the equities market, old-fashioned phone and voice trading still dominated the fixed income space. But the tidal wave unleashed by the 2008 financial meltdown and the ensuing sweeping Dodd-Frank regulation has accelerated electronic trading in fixed income too. And while not all areas of fixed income are at the same stage of automation, asset classes that have been dragging their feet are finally getting pulled into the electronic era.
"It seems to have moved past the tipping point in terms of market participants expecting more e-trading in this asset class," says Michael Chuang, the founder of iTB Holdings, provider of electronic trading software for fixed income markets.
Mike Wood, global head of Bloomberg Trade Order Management Solutions, points out that e-trading has taken off as the cost of running some businesses from a capital and operational standpoint has risen. "We're seeing a deleveraging of risk across the industry. We're seeing people look to deleverage risk in fixed income by focusing more on flow and standardized products, but also deleverage their operational overhead and technology," he says. "Over the last three years, we've seen a trend toward firms putting in place architecture and the platforms to compete electronically, as opposed to the legacy voice-driven business."
Of course, not all fixed income is born equal -- or at least, the stage of automation still varies wildly. While treasuries have already seen a fairly high level of trading automation over the last six or seven years, corporate bonds have followed a more gradual evolution, says Will Rhode, principal and director of fixed income research at TABB Group. Electronic volumes are now 22% of the fixed income market, with overall volume at $2.3 trillion in the first half of 2013, according to TABB Group.
One reason only a fraction of the corporate bond market is automated is that it's a "very institutionalized over-the-counter marketplace resistant or defiant of electronic execution patterns you may have seen in FX, equities and treasuries," Rhode notes.
"There's a significant number of dealers who have had a very healthy relationship with the buy side. They buy [these bonds] back from buy-side clients and reallocate their portfolio. There hasn't been much of a need for electronic trading."
In fact, at a recent roundtable, Morgan Stanley commented that it isn't currently focused on transitioning corporate bond sales and trading to an electronic trading platform, although the company confirmed that it has had success in using electronic trading for FX and interest rate products.
Morgan Stanley noted that it had provided an electronic trading platform for auctions of investment-grade and high-yield bonds but didn't find significant client demand because of the lack of liquidity for most corporate bonds. Further, company executives noted that the firm doesn't believe that a captive electronic bond trading platform will gain market traction.
Still, given the liquidity challenge the buy side is experiencing, corporate bond trading is likely to see a big uptake in e-trading.
Where's The Growth?
"We think it may be about to catch fire because of liquidity risk challenges," Rhode confirms. "The buy side has absorbed dealer entries as banks have deleveraged and pulled back from fixed income warehousing. The buy side has absorbed the risk. We're living in a credit bubble. People are concerned, especially the buy side, to see whether the dealers will be there to buy back bonds if the sell side wants to sell to reallocate their portfolios." One of the reasons firms are looking at electronic trading platforms is because there's hope that there might be a way for the buy side to sell directly to other buy-side firms, Rhode says.
Meanwhile, shifts in other asset classes show just how quickly things can change. For instance, the derivatives market is a completely different story from the fixed income space. Dodd-Frank legislation has taken it from an unregulated, dark marketplace with little transparency to one in which virtually all swaps are regulated by either the Commodity Futures Trading Commission or the Securities and Exchange Commission. Many swap transactions will eventually need to be cleared through central clearinghouses and traded on designated contract markets, swap execution facilities or national securities exchanges rather than being executed bilaterally as they are now. As a result, the industry will see a major shift in how swaps are negotiated and executed -- and with firms earlier this year having started addressing reporting, record keeping and clearing requirements, derivative market participants will witness an electronic trading boom.