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The evolution of cash bond electronic trading and execution strategies in Europe

Liz Callaghan, a Director at ICMA, will be speaking at the upcoming 4th Annual European Electronic Bond Trading Forum 2016

The evolution of cash bond electronic trading and execution strategies in Europe

Bond market trading is going through unprecedented change today and will continue to do so over the next years. The traditional bond trading model, mostly reliant on market makers and voice broking is being eroded. This is partly due to a natural evolution of bond trading driven by technological progress and the strive for cost efficiencies, resulting in an increasing electronification of markets and regulatory pressures undermining broker-dealers’ capacity to hold, finance, or hedge trading positions. The upcoming implementation of Europe's new trading rules under MiFID II will accelerate the market structure transformation.

Traditionally, fixed income markets have been a combination of voice market making and intermediation (using inter-dealer brokers and hybrid voice-electronic systems to source liquidity), organised largely around banks (broker-dealers) and a relationship-based network of clients. The model has primarily been:

  • Broker-dealer to client
    • Bank to asset manager, insurance company, or pension fund manager (the ‘Buy-side’)
  • Broker-dealer to dealer
    • Bank to bank or bank to inter-dealer broker (IDB) 
  • But not client to client
    • Asset manager to asset manager


Change is afoot.

For trading desks, the priority is in achieving the flexibility necessary to access bond liquidity across multiple counterparties and trading platforms while using a variety of protocols. The stage is set for a business model that has more in common with equities electronic trading than ever before. However, there are some major differences between fixed-income and equity markets There are many more illiquid bonds than illiquid shares.  Illiquid bonds increase the potential for market impact and information leakage. The combination of market impact and information leakage negatively impacts price formation in bond markets and also damages best possible result for the underlying client. So for the least amount of market impact, the fixed income buy-side is now splitting orders into categories: time sensitive (where immediacy is key), non-time sensitive, illiquid and liquid.

  • Time sensitive – illiquid: requires strategies or protocols that involve some form of bi-lateral negotiation such as voice OTC, OTC market making or RFQs. There is a sense of immediacy and due to illiquidity, possible market impact.
  • Time sensitive – liquid: requires multi-lateral low-touch protocols such as all to all, continuous auction with no worry about market impact as information leakage is not important.
  • Non-time sensitive – illiquid: requires protocols that are a combination of multi-lateral and bi-lateral, with an anonymous twist. The order can sit and wait for the other side or at the very least the best price. The order interacts anonymously with other participants but there is a negotiation phase before execution. There is no market impact as there is zero chance of information leakage.
  • Non-time sensitive – liquid: requires trading multi-lateral protocols that are low-touch, such as Central Limit Order Book (CLOB) or Smart Order Routing (SOR) technology to multiple CLOBs.  The key element to point out when comparing and contrasting equities to fixed income is that equities are about electronic trading (speed) whereas fixed income is more about the ‘automation’ of trading (optimisation).


“Survival of the fittest”

In order to endure, bond trading must adapt and innovate. The bond trading eco-system will see new entrants and innovative incumbents emerging, who will not be hindered by the fragmented IT legacy systems and practices, so they may be more agile in solving challenges for the industry. These tools, solutions and new business ventures will use advanced technology in order to emerge successfully onto the electronic trading landscape.

New Entrants:

Order Management Systems and Execution Management Systems (OMS/EMS) - Provides Straight through processing (STP) connecting internal systems across the institution. The benefits are:  smooth, efficient, seamless integration interconnecting risk management, credit checking, and position management - ensuring trades are within risk limits and meeting client obligations.

Transaction Cost Analysis (TCA) - TCA lets a firm analyse the cost of a decision to trade over a specified time period with respect to various benchmarks.

Data analysis tools (of any kind) - Deep trading history along with sophisticated data processing tools will increase the level of granularity and allow an almost forensic approach to data analysis.

Algorithmic trading in fixed income – Algorithmic trading (complex computer-based programs following defined set of instructions) is usually thought of in terms of equities trading. However, algo traders from equities now see an opportunity to leverage their existing investment in fixed income trading.

Liquidity Ratings – Several banks and buy-sides already do this to an extent today. In the future, it will become more commonplace and standardised. The likelihood is that rating agencies might take this up in order to truly standardise liquidity ratings.

Regulatory tech services – Any technology based service or consultancy firm that can assist with keeping market participants (buy-side, sell-side and platforms) on the right side of compliance and best execution will do well in the years ahead. 

Internaliser engines - Firms that operate multiple trading desks, across different time-zones or subsidiaries will require an advanced technology system that provides the ability to internalise order flow automatically.

Information Networks (INs) - Sourcing & aggregating liquidity: IN firms provide an aggregation layer, providing the trader with two key sets of functionality: global view of liquidity and a choice of trading protocols and execution mechanisms from which to select.

Consortium owned networks between buy-side and sell-sides. – Collaborative efforts between the buy-side and sell-where market participants are coming together to attempt to create liquidity in the bond markets. The hope is to enable greater transparency of trading interests across the marketplace between buyers and sellers of bonds. 

Innovative incumbents:

Price-maker Hedge Funds – Hedge Funds are not new entrants but they will adapt to the new landscape. While traditional buy-sides will most likely not step in as ‘price makers’ on Central Limit Order Books (CLOBs) or other agency-only trading venues, Hedge Funds may step in (providing it suits their trading strategies) and provide larger illiquid pricing, bolstering liquidity.

Independent Market Making firms – Independent Market Makers will start to emerge focusing on market making in specialised instruments or sectors.

Niche trading – Banks will also develop specialised expertise and be known for trading and making markets in certain asset classes or regions.

Multi-asset trading - As banks and buy-sides review their bottom lines more, it will become obvious that some IT and skill-sets can be shared. It is too expensive to have totally separate infrastructure carrying out trades that would ultimately benefit from sharing of knowledge between asset classes.
‘Super trading desks’ or ‘outsourced trading’ - Large regional sell-sides and buy-sides will create centralised super-desks where they have the market making capabilities and global reach. An outsourced provider will be able to evidence best execution to regulators and trade report to the public for their clients. Further offerings the outsource provider could provide their clients (using TCA) is, the ability to report back on broker performance measurement).

Change brings opportunity

There are signs of a new ‘electronic’ eco-system to come but no one can predict exactly how the secondary cash bond markets will look in 5, 7 or 10 years. We can only take an educated guess. Outmoded trading models are being cast off to make way for new electronic ones. New "traditions" and ways of trading are emerging. This type of innovative opportunism is set to continue.

Read the full report here;  ‘Evolutionary change: The future of electronic trading of cash bonds in Europe’


About the author

Liz's background is in fixed income & equities electronic trading (Investment Banks, Brokers and MTFs). In the past few years, Liz has focused on market structure strategy (combination of sales/trading experience and knowledge of trading related regulations). Liz's (CF30) market practitioner's approach emphasizes: electronic trading product innovation, business line rationalisation and restructuring, best execution and business development.
Liz is one of two directors on ICMA's secondary markets desk and the lead on MiFID II. She also chairs the influential Electronic Trading Working Group (made up of buy- and sell-side heads of fixed income trading from the Continent and UK) and the Platform Working Group (over 30 platform and technology providers from across Europe). Liz is frequently a conference speaker on the impacts of MiFID II/MiFIR on bond trading and the evolution of fixed income electronic trading.
Lastly, Liz is a founding member of the European FIX Committee (Original business guidelines & standards for institutional cross-border equities electronic trading between the sell-side and buy-side).

Ms Callaghan will be speaking at our upcoming 4th Annual European Electronic Bond Trading Forum on 12th & 13th September in London.  For more information please visit our event page, or you can secure your place here.

This content is provided by Euromoney Seminars for informational purposes only, and it reflects the market and industry conditions and presenter’s opinions and affiliations available at the time of the presentation.