Regulation, Liquidity Top Bond-Trader Concerns 

Shanny Basar

The buy side’s top concerns at the Fixed Income Leaders Summit in Barcelona last week were new regulation and the decline in liquidity due to the exit of traditional market makers.

Brad Bailey, research director with the securities and investments practice at consultancy Celent, told Markets Media that several key themes emerged from the summit last week which had more than 450 attendees. He said: “Liquidity, regulation and electronic platforms dominated the agenda.”

Last month the European Securities and Markets Authority released the final regulatory technical standards for MiFID II, which will govern financial markets in the region from January 2017, but there is still confusion over how the proposed rules will affect the fixed income market.

Bailey said: “While large sellside and buyside have been preparing for MiFID II, US firms and smaller European buyside firms are still confused over implementation and have little time left to prepare.”

One of the reasons for the confusion is that, despite the release of the RTS, many of the details needed to implement the rules have still not been defined.

For example, liquid bond markets will face new pre-trade and post-trade transparency disclosures but there is not yet a list of liquid instruments. Esma has chosen a quarterly instrument by instrument approach (IBIA) to define bond liquidity but a class of instrument approach (COFIA) based on size remains for newly issued instruments until the quarterly assessment has been made.

Law firm Ashurst said in a note: “How will this work? There is a concern that these issuance sizes will deem instruments liquid which are illiquid (i.e. the problem of false positives identified by some in relation to COFIA). Many in industry have suggested that significant institutional trading takes place under this level and to exclude these transactions will seriously distort the application of the transparency exemptions.”

Rhodri Preece,head of capital markets policy for the Europe, Middle East, and Africa region at CFA Institute, said in a blog that using IBIA for the liquidity classification with a quarterly reassessment is more precise while being more operationally complex.

“Ultimately, until the framework is put into operation, it will be difficult to judge whether Esma has found the sweet spot,” Preece said. “Starting off with a more conservative calibration, with scope to adjust in subsequent time periods, seems like a sensible approach and should allow market participants (and market liquidity) to adjust to the new regime.”

Bailey added: “The buyside has an entrenched fear that liquidity will disappear as non-market makers pull back from the market and these profound changes are keeping asset managers up at night.”

He continued that the buyside is concerned that liquidity from alternative providers and in electronic platforms will not be sufficient to satisfy their trading need, especially in large size.

Most buyside firms would prefer multi-asset platforms so they can use their technology from equity trading in fixed income, while being aware of the deep differences between the equity, foreign exchange and fixed income markets.

Bailey said it is too early to determine which platforms will be successful in the new trading universe under MiFID II as regulations can have unintended consequences.  For example, Regulation NMS in US equities led to an intended proliferation of venues and a fragmentation of market structure.

Brad Bailey, Celent

Brad Bailey, Celent

Matthew Hodgson, the former global head of rates & credit e-commerce platforms at Deutsche Bank, founded analytics platform Mosaic Smart Data last year to address the  fragmentation of fixed income electronic trade flows across a multitude of venues and the rapidly declining FICC revenue of sellside banks.

Hodgson told Markets Media: “Regulation has forced more bond trading onto electronic platforms and banks are having to change from relationship-based models to message-based models. Mosaic allows banks to generate insight from their trading history in an industrialised way.”

Mosaic’s data analytics, for example, allows banks to calculate P&L on individual trades, by individual trader or client or review changes in client trading behaviour to predict future behaviour. Tim Apps, the newly appointed chief technology officer of Mosaic Smart Data, said in a statement that recent research from Harvard  indicated that by 2017, firms will be 20% more profitable if they use predictive analytics.

Hodgson added: “Mosaic gives banks tools to optimise market share and profitability and brings comprehensive understanding of data to the desktop in a format that is easy  to use and understand. We want to be the Apple of fixed income.”

One bank is trialling the platform and Hodgson expects an acceleration in demand as the MiFID II implementation date of January 2017 approaches.

“While we will be continuing to focus on growing the number of banks on the platform over the coming year, we have also had a lot of interest from ECNs who want to quantify the value they provide and there is a huge opportunity with the buyside,” he continued.

Bailey said: “Europe is boiling the ocean in fixed income with MiFID II and firms are trying to understand the myriad changes, the timing of change, and the many complicated means of judging the type of rules that will apply in government and corporate bonds.

Featured image by Cacaroot /Dollar Photo Club

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