According to Philippe Rakotovao, deputy CEO of MTS and EuroMTS, his firm’s business model - and the commitment it demands from participating banks to make markets - must be seen in context. “In Europe, you have 11 borrowers that issue benchmarks in each maturity,” he says. “They all generally have the same issuance policy, methodology and broad targets, but they compete for investor attention. In the US, there is just one issuer [the US Treasury].”
The roots of European trading and the MTS model should also be seen in their historical context. “Europe’s secondary market was developed during the late ‘eighties and early ‘nineties,” Rakotovao says. “The MTS model owes its roots to agreements that were already being used. The only difference [compared with the situation before MTS] is that MTS has provided a tool to help monitor the commitment and facilitate the harmonisation of standards,” he adds, arguing that the platform’s role has been equally applicable to the supra, agency and covered bond sectors.
While conceding that some players find it more challenging to quote electronically, Rakotovao contends that “today’s technology is at such a level that dealers can alter their price in a split second. They have links between their sophisticated pricing engines and MTS, so it’s possible to avoid all unwanted trades.”
He concedes that the market-making commitment is in some circumstances a burden, while denying that that invalidates it. “It is true that the ideal scenario for bankers would be to have only the juicy business with no constraints,” he says.
A comparison can be drawn with the motorway business, where in return for collecting toll revenues, private companies are obliged to maintain standards such as ensuring an adequate number of petrol stations, well maintained roads and a sufficient number of places for drivers to rest. “The state gives away these revenues, but the private company must stick to certain criteria that cost it money,” Rakotovao says. “If a company applies to manage a road, it is because it believes it is going to make an overall profit. The government bond market is the same – no one is coerced into signing a contract; they do so voluntarily and thereby commit to providing a secondary market. It is important that there is a well-organised liquid and transparent market.”
Banks often complain that the market-making commitment on MTS leaves them vulnerable to large and potentially destabilising trades, but Rakotovao rejects this. “Banks cannot say the MTS model is a constraint given they are quoting more bonds at tighter spreads [than their contractual obligation],” he says. “They see value in doing this, they make money out of volume. Why else would they voluntarily adopt a more challenging commitment?”
As for the capability to put in really large trades, Rakotovao points out that it is within the remit of the regulator to ensure that rules are clear and that regulatory principles are adhered to.
“This does not necessarily prevent banks from undertaking big trades; there is nothing to stopping big trades from being put on,” he says. “There is currently no quantitative constraint on MTS, the previous restriction having been waived by the board – which consists of a majority of banks.
“[Acceptable deal size] is a generic concept, and it is up to regulators to define what is normal behaviour. The wholesale market is not there just for the big banks; it is also a place where public saving is conducted. The government is obliged to ensure its taxpayers are protected, and that means it has to ensure coherent market behaviour.”
That sounds like an admission that big trades cannot be tolerated. But Rakotovao questions the view that the market-making commitment is the real issue here, and that the problem of bank profitability in the sovereign sector lies elsewhere. “There is a risk of banks overbidding at auctions, and the subsequent dumping of inventory on clients. I understand that the European Primary Dealers’ Association was created to resolve these problems. I am told that a 1% market share costs ?5m. I’m not responsible for banks’ P&Ls, but if a bank’s average share is 3%, that must mean it starts the year with a ?15m loss. This is clearly a problem that needs to be resolved,” he says.
Bankers agree that accessible liquidity on a broad product range helps create business. However, if liquidity and price transparency were reduced, small to mid-sized banks would be less likely to participate – and this might ultimately lead to an unhealthy concentration of business in a few truly global banks.
MTS’s acquisition by Euronext will only be completed by year-end, so no work has yet been undertaken on mutually beneficial ventures. Nevertheless, there could be tremendous synergies between Euronext’s derivative business and MTS’s cash business – with scope to promote bond-index trading through stock exchanges, for example. “The ETF [exchange-traded fund] business could be developed,” Rakotovao says. “We think this might be a big area of co-operation.”
Another key area of potential collaboration relates to corporates. “If you take Euronext and [its partner in the MTS acquisition] Borsa Italiana’s access to corporate issuers and our knowledge of how to organise bond markets, there could be significant synergies,” he says.