MiFID II Data To Drive Bond Market Structure

Shanny Basar

True innovation in bond market structure is two to four years away and one of the most important drivers will be the data generated by new European Union regulations.

The International Capital Market Association report said in its report for the first quarter of this year that electronic trading is increasing in the bond market, driven by pre- and post-trade efficiencies and the need to access new sources of liquidity as banks have shrunk their balance sheets.

“However, MiFID II is shifting gears and is significantly speeding up the evolution of electronification of fixed income trading,” added ICMA. “MiFID II is changing trading models.”

The regulation which came into force on 3 January 2018 introduces new venues, extends best execution requirements into fixed income for the first time and introduces pre-trade and post-trade transparency.

ICMA continued that, as result, execution strategies are becoming more complex. For example, MiFID II bans broker crossing networks so investors need to know which counterparties can or cannot assume trading risk as systematic internalisers. However the ability for SIs to operate a “hybrid” model of risk-facing and riskless trading is at the discretion of national regulators, and some investment firms may only provide firm pricing or work an order, but not both.

“In 2018, in the countries where the hybrid model is ending, many traders are considering not trading orders,” said ICMA. “Buysides may instead work on a relationship and indicative basis. Execution strategies may involve knowing which trader to “go to” for this style of trading.”

When executing with an SI, the SI has the responsibility to report in all circumstances. ICMA noted that executing with an SI does not guarantee best price, just the obligation for the SI to report.

The association added that everyone agreed in a series of MiFID II implementation workshops last year that the greatest innovation will take place in bond trading market structure once the investment needed to comply with the new regulations has dropped off.

“Budgets are stifled for innovation, unless directly related to MiFID II implementation,” said ICMA. “True innovation will occur, but this is likely to be two to four years down the road. One of the key drivers for innovation will be the data that MiFID II will generate.”

For example, under MiFID II more bonds will be subject to a trading obligation – this allows large or illiquid trades to be negotiated  bilaterally but executed and reported via a trading venue.

The report listed categories of future data and technology-led innovation – new routes to access liquidity; new market data products; and new trading patterns which may emerge using execution management systems and FIX protocols, the standard messaging format used in financial markets.

There are examples of innovation already happening in bond markets.

Dutch bank ING is expanding the use of Katana, an artificial intelligence tool, across its fixed income trading division after finding that it led to significant performance improvements. Katana was tested by the emerging markets credit desk in London last year and allowed faster pricing decisions for 90% of trades. Traders were able to offer the best price four times more frequently as an algorithm can provide forward looking predictions of the price that will win a request-for-quote within a certain confidence range.

Tradeweb, the electronic fixed income and derivatives execution platform, said last year that clients and volumes for its Automated Intelligent Execution offering, which automates RFQs, increased five-fold over ahead of MiFID II.

Illuminate Financial Management, the venture capital firm which funds fintech companies in capital markets, invested €2m in AxeTrading last year. AxeTrader, the technology provider’s flagship platform, provides banks, broker-dealers and buyside firms with an aggregated view of fixed income liquidity including axes, runs and quotes from the electronic venues, messaging platforms and voice channels used by a client and can help meet the MiFID II best execution requirements.

Another Illuminate investment, TransFICC, is joining Accenture’s sixth FinTech Innovation Lab London.

TransFICC allows firms to use one connection to access multiple fixed income and derivatives venues as the volume of electronic trading increases.

Consultancy Greenwich Associates said in a report last year, Technology Transforming a Vast Corporate Bond Market, that the buyside is deploying technology that leverages data and analytics and enables investors to access new electronic and traditional sources of liquidity.

“If providing buyers and sellers of corporate bonds with tools that allow them to trade with each other marks the first phase of the market’s evolution, gathering, analyzing and putting to work data is phase two,” added Greenwich. “In coming years, we will see bond trading venues morph into data and  analytics providers, with their liquidity pools as the mere foundation of the business.”

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