Fixed income markets in Europe are changing. The MiFID reforms being formulated in Brussels will have a profound impact on all market participants, buy-side and sell-side, execution venues and infrastructure providers. But while the policymakers have been debating the final calibrations, the market itself has been evolving.
Slowly but surely, fixed income market participants have taken it upon themselves to instil their trading operations with the transparency that has formed the basis of the regulators’ discussions – thereby setting best practice for the new market landscape before the authorities have finalised the proposed regulatory reforms. And the levels of transparency required in today’s risk-adverse and compliancy-sensitive environment can only be achieved through one method – electronic trading.
While the new regulations are unlikely to actually make electronic trading mandatory, the European Commission has stated that it does not see that the regulatory objectives can be achieved through the use of pure voice trading.
Amongst its major updates, MiFID II is expected to propose a large extension in the regulation of all trading venues that are not already regulated venues. This will create two new categories of regulated platforms for fixed income – Organised Trading Facilities (OTF) for multilateral platforms, and Systemic Internalisers (SI) for bilateral platforms. The effect will be a move towards electronic platforms for a wider range of fixed income products, with Celent estimating a 45% rise in electronic trading amongst the sell-side by 2015, and a 50% rise amongst the buy-side (Fixed income in Europe – read for the tornado? – Celent, 2012).
The path to electronification
Three years of crisis in the Eurozone have thrust the government debt market into the public spotlight and highlighted the benefits of e-trading. Electronic platforms are able to increase the available market transparency, and in many cases use transparency as a central characteristic of the trading arrangements. For example, electronic order-matching systems show the immediate position of the market at any time.
When selecting a platform, participants must focus on the key criteria necessary to stay ahead in today’s competitive markets – namely access to liquidity, better price discovery with a higher quality trading experience, more certainty, post-trade transparency and straight through processing.
However, for traders, measuring the functionality and benefits of one electronic platform over another comes secondary to recognising why they should move to such a platform in the first place.
One key reason for the shift from voice to electronic is speed. Using an electronic platform allows traders to find out within seconds whether they have done their deal – as soon as the trade matches, it’s done. In the B2C space, e-trading dramatically cuts latency between a fund manager and the counterparty on the trading platform.
Flow of data through an organization is also an important consideration. Electronic platforms offer straight through processing (STP), a highly efficient process that strips out much of the operational risk associated with a trade and enhances compliance and best execution.
In today’s cost-sensitive environment, another key factor to note is that switching to electronic trading also reduces the overall cost associated with the trading process. Electronic trading creates a self-contained environment where the trader is able to initiate an order, execute it and clear and settle it without ever writing a ticket. This high level of efficiency, combined with full integration between all the bank’s systems, significantly reduces spend on disparate systems and costs associated with operational errors.
An appropriate solution for today’s markets
In addition to regulatory changes, the market continues to evolve in a manner which is better suited to electronic trading.
Bond traders at investment banks that were once specialized in particular markets or product types now need broader knowledge of both the countries on which they concentrate and the European government bond marketplace as a whole. This has led to an evolution of processes and organization at institutions involved in bond trading. These new arrangements lend themselves to the use of increased levels of automation. Electronic markets such as MTS offer traders access to the entire spectrum of European government bond issues on one platform, delivering a level of efficiency that simply would not be possible when trading in a wide range of bond markets via traditional voice channels, and various tools to enable banks to serve their customers more efficiently and effectively.
To avoid moving prices in less liquid markets, traders have also started to break up big single trades into smaller amounts that will be bought or sold gradually during the course of a whole day. Executing a large number of trades over the phone introduces a range of unnecessary inefficiencies, costs and risks – electronic trading is the perfect solution to this new market dynamic.
Liquidity is scarce and needs to be concentrated, aggregated and managed carefully. Forward-thinking market players are also looking to electronic platform providers that are making efforts to aggregate and concentrate liquidity while the cyclical European downturn plays out and new regulations are finalized.