Connecting Fixed Income

Shanny Basar

Fixed income markets are moving toward the commoditization of connectivity similar to that experienced in other more electronic asset classes, according to the International Organization of Securities Commissions.

Iosco said in a Research Report on Financial Technology that a significant increase in the number of electronic trading venues and the fragmented nature of the fixed income market has raised the importance of connecting to multiple platforms in order to aggregate liquidity across disparate pools.

“These developments are moving the industry toward the commoditization of connectivity in fixed income markets, similar to that experienced in other more electronic asset classes,” said Iosco. “Such commoditization has the potential to offer significant benefits to market participants.”

The first benefit is a richer, more diverse ecosystem as the buyside has historically had to rely on a few incumbent market makers. Therefore connectivity based on open standards, such as the FIX messaging standard, could create new providers of data, analytics and connectivity. In addition, vendors will be forced to compete on providing value-added services rather than basic connectivity.

There has been an increase in the number of electronic trading venues and a variety of trading protocols are being offered to promote price discovery, including order books with live and executable orders, session based-trading, and platform-determined midpoint pricing. The report said platforms and technology providers are increasingly focusing on identifying and matching firm orders, rather than quotes and connecting all market participants, including just buyside firms.

“Information networks are developing where the emphasis is on identifying pools of liquidity rather than trying to create liquidity,” added Iosco.

For example, Algomi is a network that provides liquidity intelligence by using data to help locate any bond, rather than focussing on execution.

Last November Algomi announced a partnership with Euronext, the pan-European exchange, to deploy the bond information network’s technology for a new multilateral trading facility so dealers will also be able to search for liquidity with other dealers. Paul Humphrey, head of fixed income, rates & FX at Euronext, said in a blog at the time: “The current limited data on buyers and sellers, results in low liquidity and this platform will use algorithmic smart matching processes to search for liquidity and best execution.”

Iosco continued that recent innovations related to structured and unstructured data in the corporate bond market have led to a dramatic increase in the availability of such data for market participants and improved price discovery, liquidity sourcing, timing and overall transparency.

The rise in electronic trading platforms has led to more available market data in structured formats. In addition new regulations, such as MiFID II in Europe from 2018, set record keeping and reporting requirements.

Unstructured data such as social media, voice, chat, and emails can also now be filtered, mined, and stored as regulators have introduced new requirements for trade reconstruction and audit trails. Iosco said the most prevalent use of unstructured data by vendors includes the creation of estimated pricing and liquidity ratios or scores, which increase market transparency as many bonds are illiquid.

“However, market participants face challenges in parsing and filtering data streams to differentiate between types of prices received and to attempt to prevent repetitive prices from different sources that could give an inaccurate picture of market depth,” added Iosco.

However Iosco warned there are also risks related to the adoption of new technology such as time, functionality and sustainability and meeting the specific needs of the corporate bond market, which do not trade in the same way as equities.

“It is often difficult to reengineer consistently the buyside relationship experience in trade initiation and negotiation, liquidity delivery, price discovery, and firm price quote features – all the while protecting buyside client anonymity – on new technology platforms,” added Iosco. “Along this unique order custody chain, difficulties in parsing prices marketed simultaneously on multiple platforms have also emerged, creating the appearance of duplicate orders and misrepresented market liquidity.”

There is also concern that the sheer number of corporate bonds available to trade, the lack of a centralized liquidity pool, and many different execution preferences by market participants will make it difficult to achieve rapid increases in efficiencies for locating and pricing securities. In addition electronic platforms may not perform during stressed market conditions, although this may be mitigated by the diversification of price makers beyond the traditional dealer community.

Iosco said: “Product diversity, with the tens of thousands of unique corporate bond issues, coupled with the predominantly buy and hold nature of bond investors is perhaps the most significant challenge in fostering a market structure that provides price transparency and access to liquidity.”

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