Buy Side Eyes Market Structure Changes

Terry Flanagan

Market structure changes have led to a rise of fragmentation of liquidity, while bringing greater competition in the form of electronic trading venues.

“Changes to market structure over the last 10-15 years have arguably brought both good and bad,” said Ryan Larson, head of equity trading, U.S. at RBC Global Asset Management. “Of the good, technology has allowed buy-side desks to source more tools in the quest to access liquidity. Firms must embrace a mix of both technology and human capital in their trading process to allow traders to effectively source liquidity in the multiple-venue, geographically-fragmented environment that exists today.”

Various asset classes are moving through different stages of maturity, according to a report by Boston Consulting Group.

Cash equity brokerage has the highest level of electronic volumes among all asset classes.

Combined, cash equities and prime services account for $200 million to $500 million of IT spending at Tier One financial institutions, according to the BCG report. This spending is driven by client market access, algorithmic trades, and mid-to-high frequency trading.

In fixed income, the situation is different. In 2012, less than 20 percent of credit trades were electronic, far below the level in equities and FX, both of which are now above 50%, according to the report.

Electronic trading in the fixed income market pertaining to corporates and asset backed securities still has limitations.

“Unlike the stock market, where there is only one price for a security, the same company may have hundreds of bond issues that are outstanding,” said Thomas Shugrue, principal of Carolina Capital Markets, an institutional fixed income broker-dealer, in a comment letter. “Each one of these issues has different characteristics, such as length of maturity, call dates, size of issue etc. The secondary bond market is truly a negotiated market. Depending on the underlying credit of both the corporation and the asset backed security, the ability of a dealer to put a two sided market on all securities is unrealistic.”

Although credit will continue moving up the “electonification” maturity curve, full development will take years to achieve.

The reasons are two-fold, according to the BCG report. First, there is high fragmentation in the corporate bond market (around 40,000 CUSIPS in the U.S. alone, and even the most comprehensive platforms can only cover a fraction of them.
Second, most asset classes have an information advantage over credit, making the market relatively opaque.

Currently, Finra’s TRACE system does require reporting on riskless principal transactions.
“In TRACE reporting, you have the trade that took place between two brokers (inter-dealer trade) and you also have the reporting of the trade and price to the customers,” said Shugrue. “Presently, 95% of all corporate bonds are TRACE reportable.”

One measure that may increase transparency would be a change to Rule 10b-10 that would require the markup/markdown on the fixed income trade to be on the confirmation. “While the fee is available if one goes into TRACE, having the markup on the confirmation would provide further disclosure,” Shugrue said.

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