Fixed Income Favors ATS Model

Terry Flanagan

Global changes in fixed-income market structure, including the dominance of the buy side and the impact of regulations, are favoring alternative trading systems such as MarketAxess in credit and Tradeweb in rates, according to Kelley Millet, chief executive of Banca IMI Securities.

“What you are seeing is the emergence of other trading models, whether that’s all-to-all trading on the MarketAxess platform or whether that’s the central limit order book type of trading that’s occurring at firms such as BondPoint and Bonds.com,” Millet told Markets Media.

Millet will speak about this topic on the Liquidity and Market Structure panel at Markets Media’s Fixed Income Trading & Investing Summit on May 5.

Millet, a former president and board member at MarketAxess, joined Banca IMI Securities in January 2014 with a mandate to substantially build-out Banca IMI’s presence in the U.S. It’s owned by Intesa Sanpaolo, which he said is arguably the world’s biggest and best-capitalized little-known bank.

Banca IMI’s banking and securities businesses runs the gamut from origination, equity and debt capital markets and derivatives marketing, to fixed income sales, and an integrated equity business which includes cash equity, equity brokerage, and stock loans.

Over the last decade, and certainly since the global financial crisis of 2008-2009, the role of the buy side in terms of providing liquidity in investment grade credit has greatly expanded in contrast to the sell side. “If look at not only traditional asset managers but also ETFs, the size and scale of the buy side now dwarfs the sell side,” Millet said.

He said that the buy side is holding almost $1 trillion in investment grade assets. Primary dealers held about $250 billion in investment grade at their peak, and now hold less than half that amount.

“The fundamental issue you have in looking at the macro picture is, you have a huge buy-side complex that now dwarfs the balance sheet available for the primary dealers,” said Millet.

The sell side is faced with the so-called Volcker Rule, which restricts market making activity to being “customer-based, and not in any way, shape, or form, ‘propriety in nature,’” said Millet. “What historically was a proprietary trading capability among the primary dealers simply doesn’t exist anymore.”

New capital regulations, both within the U.S. and globally, require the primary dealers to hold more capital against their assets. In addition, the U.S. Securities and Exchange Commission is likely to focus on best execution, especially as it relates to banks with a large retail customer base.

Banks also have an enormous investment in both mid-office and back office infrastructure, which will require even more investment given the requirements around compliance and other issues in the current environment.

“You have both a macro mismatch between the size of the buy-side and the available balance sheet, and you have a regulatory push in terms of risk-weighted assets and the capital that one has to put against it,” said Millet. “You have a legacy cost issue in the mid-office and the back office, that obviously is exacerbated by incremental spend around compliance.”

Featured image via Dollar Photo Club

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