Transcript Minutes of Fixed Income e-Trading Conference

Minutes of Fixed Income e-Trading Conference
Bond Market Association
14-15 March 2006
Old Billingsgate Market, London
Author: Osman Saglam (B.E.E.P. cvba)
B.E.E.P. cvba ● Grensstraat 57 rue de la Limite ● B-1210 Brussels (Belgium)
[email protected] ● WWW.BEEP.BE
Minutes of Fixed Income e-Trading Conference
I . Introduction
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By way of introduction, the Bond Market Association reminded the following points :
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1- The objective of e-trading trading platforms is to build liquidity to add enough participants and
order flow to provide the opposing trades, and have the region's platforms bolster liquidity for fixed income
products. E-trading systems do well in high liquid, high volume markets (Shaded area C in chart below), with
participants benefiting from greater transparency, efficiencies and lower transaction costs. With the core
costs of running platforms fixed, e-trading helps to scale businesses and expand profits, such that when
trading volumes reach a breakout level, spectacular returns can be achieved.
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2- Electronic trading platforms in the U.S. and Europe continued to mature and
consolidate in 2005 as online execution of fixed-income transactions has become
virtually commonplace. The continued growth in the use of in online trading platforms
has resulted in a well-established core group of systems.
Weaker platforms continued to exit the space. Surviving platform vendors have
continued to improve their product offerings, which have in turn enhanced the use of
online trading for dealers and customers.
3- Apart of the development of a FIX certification program (with the dynamic
collaboration of FIX Protocol Ltd. and the Bond Market Association), the industry has
made significant progress on initiatives such as the permanent progress of a common
message hub (a means towards implementing straight-through processing in the fixedincome markets); the improvement of a « market data definition language »
(comprehensive definitional standards related to bond descriptions); and the
consolidation of standards related to operational aspects of prime brokerage services.
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4- It was mentioned that institutions need to further invest in their STP
functionalities to ensure fluid execution and settlement of trade, while vendors do
well to augment their product offerings beyond the basic fixed-income trading
applications to include peripheral services like providing historical pricing and
order management.
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5- Traders also accelerated their adoption of electronic execution for less
liquid products such as corporate debt securities, according to anecdotal evidence.
Platform vendors encouraged the adoption of electronic trading by adding or
enhancing features and services on their trading systems such as connectivity for
automated trade processing; pre-trade services such as research, analytics and
calculation software; and services tailored to syndicated underwriting of new
issues.
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In summary, the trend towards platforms supporting trading in both the U.S. and
Europe continued in 2005. Participants in markets for liquid fixed-income
products like sovereign debt continued to incorporate electronic execution as an
integral component of their trading.
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• Minutes of Fixed Income e-Trading Conference
II. The impact of e-Trading on Fixed-Income Markets
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E-Trading has had a huge impact on the investment process—in
productivity, decision making, price transparency, the investment
universe. The result of the technological breakthroughs has been to
increase price transparency and accelerate execution times while
providing more accurate models, reams of data, software to mine the
data, and better hedge vehicles.
The ultimate result is a fixed-income market that is so efficient that alpha
is increasingly difficult to find. At the same time, technology has made
managers better at finding alpha. Technology has also made the market
more complex. And a complex, efficient market puts a premium on skill.
Markets also tend to become liquid at the same time, but liquidity is not
the same as market efficiency.
Technology always makes markets more efficient; it sometimes (but not
always) makes markets more liquid in the process.
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In short, there are 4 impacts of e-Trading on Fixed-Income Markets :
1- Productivity
The rate of growth and progress in technology has been astounding. The
proportion of customer business, as opposed to trading with other dealers, has
risen. That is, the market has evolved in such a way that the customer business
has grown faster than the market overall. And now, 50 percent of principal
amount is traded electronically. The number of tickets per month has tripled,
which means that the average ticket size went down a little bit, but the average
customer voice ticket has increased 150 percent.
In a matter of seconds, the quotes come back, the trader clicks on the best one,
and the trade is booked automatically. Even a slow person with a mouse can do
this trade in 15 seconds.
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2- Decision Making
The second area in which e-trading has made a huge impact is decision
making. How important the software technology has been to decision making
in bond trading is impossible to categorize quickly and simply. Several dozen
types of modeling and decision support tools exist.
Models are applied to drive decision making across broad swaths of the fixedincome world:
• options/derivatives valuation,
• mortgage-backed and asset-backed securities prepayment forecasting,
• credit default and recovery analysis,
• portfolio structuring and optimization,
• risk management, and
• asset price evaluation, filtering, and short-term
prediction.
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3- Price transparency
Price transparency has increased by leaps and bounds. And
when market participants can see what is going on, markets
become more and more sophisticated (Please refer to Nick
O'Neill presentation - on MIFID - about this point).
4- Investment Universe
The fourth area in which technology has had a large impact
is the investment universe itself. The main thesis is that the fixedincome market creates products based on participants’ ability to
model them, to price them, and to manage their risks. The model
is the product.
For example: Interest rate swaps, caps, and floors; exotic
options; collateralized debt obligations (CDOs); and
collateralized loan obligations (CLOs)—all are technologyenabled products.
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In summary, e-Trading makes markets more efficient, and by
making markets more efficient, it makes alpha hard to find, but it
also makes managers better at finding alpha. Similarly,
technology introduces new products and new techniques into the
marketplace, so the market becomes more complex. And a
complex, efficient market raises the bar in terms of the skills
needed to operate successfully in that market.
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ELECTRONIC SYSTEM ATTRIBUTES
Flexibility
and
Market Support
User
Friendliness
Liquidity
Technology
Transparency
And
Cost Efficiency
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III. MiFID - transparency at the cost of liquidity?
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Please refer to Nick O'Neill presentation.
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IV. Will eTrading ever be able to meet the needs of the hedge
fund community?
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With faster transaction and settlement times, fund managers need to
know the status of the positions they have, what cash is available to trade
and which way their chosen market area is moving.
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Many institutions have profited from fixed-income trading in Europe due
to high levels of liquidity and a reasonably volatile market. Still, it is those
who have had the foresight to create information-packed front-to-back
infrastructures that are set to reap further rewards. And, with estimates
suggesting up to 75 per cent of fixed-income trading will be managed
electronically by 2007, the ride should prove interesting.
B.E.E.P. cvba ● Grensstraat 57 rue de la Limite ● B-1210 Brussels (Belgium)
[email protected] ● WWW.BEEP.BE
B.E.E.P. cvba ● Grensstraat 57 rue de la Limite ● B-1210 Brussels (Belgium)
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V. The future trends of eTrading
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E-Trading will become good enough in terms of the data-mining
techniques that it will allow some to develop more practical strategies for
trading, but also for risk management, and hedging.
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One of the most fascinating contributors to market efficiency is the
increasing accuracy of the models (in financial products and derivative
securities). An interesting feedback loop happens with models. In typical
option models (and there are many to choose from), some underlying
assumptions are common:
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• the price of the underlying security is continuous and transparent,
• the underlying security can be bought or sold or
sold short in arbitrary amounts at any time,
• no commissions are involved,
• no taxes are involved, and
• investors can borrow or lend cash at a single rate.
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In short, a major trend enveloping electronic trading platforms lately will
be acceleration in the development of value-added services to enhance
the product offerings. These services – spanning historical pricing data,
confirmation and allocation services, order management systems and
electronic research delivery (produced by third-parties/dealers) –
complement the basic functions of price discovery and execution, and can
help to reduce end-user costs.
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VI. Question and Answer Session
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Question 1 : With more complexity in financial products and
derivative securities, is more time being spent on due diligence
and clarity (MIFID), which might actually be reducing
productivity?
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There’s no question that the complexity of today’s
instruments requires more due diligence. If your objective is to
perform due diligence to a level that you understand a
structure, it will take you a very, very long time. And all forms
of asset-backed securities, CLOs, and CDOs have
correspondingly rich structures. Technology frees up time in
other ways, but it surely will not do the due diligence for you.
And caveat emptor still applies.
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• Question 2 : At what point and under what circumstances
will the trade execution capabilities and price
transparency of the developed markets extend to emerging
markets?
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It will be a long, slow process for any illiquid asset to
become actively traded electronically. The frenetic pace
of electronic trading activity is taking place, on a
percentage basis, primarily in two highly liquid asset
classes—government bonds, including European bonds
and U.S. Treasuries, and the foreign exchange market.
The technology will eventually reach other asset classes
but only when its usemakes sense.
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Question 3 : Is the new practice of equating “transparency” with
“liquidity” misguided?
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Liquidity is harder to define than efficiency and has been defined
in a number of ways: the ability to get the best possible price for an asset
in the shortest possible time, the difference between the bid and ask
price, or the ability to move size quickly without affecting the bid–ask
spread. In some cases, increased technology, increased transparency,
and increased efficiency actually hurt liquidity.
Therefore, greater market efficiency can decrease liquidity. So,
liquidity for the trader who wants to move large blocks is hurt, but it
occurred in transparent markets as bid–ask spreads narrowed, which is
a sign of market efficiency.
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• Question 4 : What trends and innovations do you expect to
see in fixed-income and related derivatives this year?
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E-trading will increase transparency and markets
will deepen. Participants will extend their scope and
focus on more sophisticated products to enhance yields.
The euro capital market will become more mature as
differentiated credit markets develop. There will be more
asset-backed deals, bank and insurance capital raising
transactions. Institutional and corporate credit
derivatives use will rise as a result of efficiency of capital
utilisation and regulatory arbitrage.
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