Thursday, 24 January 2019

Bond e-trading shake-out gathers pace

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Scrutiny over the raft of bond trading platforms has ramped up following the failure of one high-profile new entrant and the slow take-up of quote-driven click-to-trade protocols on established platforms.

Bondcube was forced into administration last month after key backer, Deutsche Boerse, cut funding. Its misfortune has not deterred Liquidnet, an established equity dark pool operator, which is preparing to launch its anonymous trading network for high-yield and convertible bonds in September.

It is one of many firms attempting to address dwindling secondary corporate bond liquidity, after Basel III capital rules forced dealers to slash inventory, by opening the door for the buyside to post liquidity on its platform.

The firm, which acquired corporate bond platform Vega-Chi, may have one competitive advantage. Legal contracts for the new fixed-income network are fungible with existing contracts for the equity dark pool, enabling multi-asset clients to leapfrog months of legal work typically associated with connecting to new platforms.

That is appealing to some asset managers according to Bob Holland, senior product manager for Linedata, a global solutions firm providing trading and compliance services to fixed-income investors. The firm is assisting clients as they link up to preferred platforms.

“The challenge for our clients is to determine which of the 15 venues will survive,” said Holland. “We went through a similar process 20 years ago and only three or four made it through – it will be the same this time around and many of the largest asset managers are only signing up to three or four providers.”

The big three established platforms – Tradeweb, MarketAxess and Bloomberg – look set to stay, and regional players may prosper in local markets. SGX, for example, plans to launch its pan-Asian bond network later this year.   

Click-to-trade limitations

But the gap for alternative providers remains remarkably narrow. Established operators have struggled to gain traction with quote-driven price streaming models that dominate the equity world, and request-for-quote protocols continue to represent over 90% of electronic trading on established fixed-income platforms.

“RFQ remains a very important model that reflects the principal-based nature of the business and that large and ‘real-money’ institutions want to know who they are dealing with,” said Enrico Bruni, head of Europe and Asia at Tradeweb. “There’s been a lot of discussion on other models, and although we don’t think that RFQ is the only way the market will trade in future, it will remain predominant.” 

Click-to-trade models currently on offer fall short of the agency-style protocols of the equity world. According to some, they are more akin to an ultra-fast electronic version of the traditional RFQ model as streamed bond prices are typically subject to negotiation. 

“The holy grail is to move to a real click-to-trade model and while a couple of vendors are pretty close to that and can show a two-sided market, they’re really capturing the market behind the trade on a post-trade basis,” said Holland. 

The lack of executable liquidity behind displayed prices frustrated Bondcube clients, contributing to the firm’s demise. But some platforms are finding streamed prices to be firmer than others. 

“Streaming prices may be subject to a last look and in some cases participants may engage in some sort of negotiation, but the acceptance ratio for click-to-trade prices is very high and clients are aware whether a price is firm or not firm,” said Tradeweb’s Bruni.

“There’s a reputational aspect to it as negotiations are always disclosed and counterparties want to be seen to be offering real prices.” 

Buyside firms have largely shunned click-to-trade protocols as larger players believe they can achieve better pricing via RFQ. Failure to secure the best price could put them in breach of Finra best-execution requirements. 

“Institutional real-money investors feel that due to their size and order flow type, they often get an improvement in the quoted  prices, but for the retail client base, click-to-trade is proving much more popular,” said Gareth Coltman, head of European product management at MarketAxess. 

Changes could be on the horizon as pre-trade transparency requirements included in last year’s Mifid II consultation could push the market a step closer to equity-style execution. 

Technical standards for the new regulation are expected in September, but many providers are addressing pre and post-trade transparency in anticipation.

In April, MarketAxess launched a composite price tool for European credit. The tool updates a universe of 3,500 bonds every five seconds, combining prices from the firm’s Trax pricing service with streaming indicative prices from contributing dealers.

“It means that investors don’t necessarily have to rely on RFQ models for price discovery. In theory you can use the Composite Price tool to provide an idea of where the executable price is and the reticence to click-to-trade should diminish,” said Coltman.   

Expanding buyside role

MarketAxess has seen rising demand from non-dealers to post liquidity via its all-to-all platform, Open Trading, which was launched in conjunction with BlackRock. Clients can post liquidity on a RFQ basis through Market Lists – still the preferred method – or combine their own axes with dealer inventory on Open Markets, where some bilateral negotiation is available.

More than 60% of second-quarter open trading liquidity in the US came from buyside firms, compared with 25% in Europe, where the service went live at the start of this year.

Liquidnet offers a similar all-to-all model with two protocols that are a step closer to equity-like execution. A central limit order book enables all participants to post prices and exchange liquidity based on firm executable prices, while a block trading facility for orders above US$5m limits visibility to contra orders within proximity to each other.

“Click-to-trade makes trades easier and quicker, but if you want to trade US$100m of bonds it’s still going to be in a negotiated market,” said Linedata’s Holland. “The small stuff will happen on venues but it’s not clear where the cut-off is going to be.”

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