Defragmenting Fixed Income

Terry Flanagan

A group of buy-side and sell-side participants are collaborating on a utility, dubbed Project Neptune, which is meant to interleave islands of liquidity in fixed income to create a centralized system of bids and offers.

“Project Neptune is an attempt to unify what could become a fragmented market through all these individual initiatives by taking a totally different stance,” Sassan Danesh, managing partner at Etrading Software, told Markets Media. “Our perspective here is not to worry about the fragmentation that is being potentially caused by lots of new initiatives, but actually embrace that fragmentation and say, in a fragmented world, how do we then re-aggregate that liquidity that might exist in lots of individual initiatives?”

Societe Generale and Axa Investment Managers are among the institutions that have signed on to Project Neptune.

During a June 20 speech on disintermediation in the financial markets, SEC chair Mary Jo White took note of the fragmentation in fixed income markets.

“It is striking that the dramatic technological advances that have transformed the equity markets over the past decade have had only a modest impact on the trading of fixed income securities,” said White. “While today there are a number of electronic systems that facilitate trading in fixed income securities, they tend to be inventory-based, providing information primarily on the bonds their participating dealers would like to sell.”

In addition, information about the trading interest reflected on these systems often is restricted to participating dealers and select customers. Although new technologies are gradually being incorporated into the trading of fixed income securities, producing efficiencies and some pre-trade pricing information, it appears they are being used primarily to support the traditional dealer model.

“The development of a workable best execution rule for both the corporate and municipal bond markets is vital for the protection of investors and enhancing price competition,” White said.

The concept is not new in the electronic trading world. “When we look across the asset classes, equities for example have a much more integrated market structure,” said Danesh. “Around nine months ago I first posed this question: Why is it that fixed income doesn’t have it?”

This led to discussions with both sell-side and buy-side participants about ways of achieving unification in the fixed-income market, which resulted in Project Neptune.

“The common view was that we should be looking at a market structure that works with the grain of the business models that the buy side and sell side have today,” Danesh said. “Some of these initiatives have very novel ideas as to how they can effectively accelerate the turnover of inventory.”

The first stage of Project Neptune will begin shortly, said Danesh, adding that “it is in advanced discussions with the community. Clearly the model is very innovative in the sense that we are saying let’s just embrace the fragmentation and unify the market. That’s very different from how anybody else is thinking about it.”

The vision is that it should be an open utility and available to as many of the buy side and sell side as possible. “We want to work with a representative sample of the marketplace to come up with a sensible approach, and once we’re comfortable that that works for the industry, then of course, opening it up to everybody,” Danesh said.

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