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Changes in fixed income market structure is being driven by regulations, particularly those dealing with OTC derivatives, according to Kevin Arnold, head of Foreign Exchange, Rates & Credit-Americas at UBS.

“The regulations, for the most part, has only really touched on interest rate swaps and credit derivative swaps,” said Arnold, who will discuss fixed income market structure at Markets Media’s Fixed Income Trading & Investing Summit on May 5. “The regulatory push has been focused on a fairly narrow product set, but has given rise to a debate that surrounds what else could this new market structure apply to given the increasing costs of capital, and the increasing costs of providing liquidity.”

Arnold manages the sales trading business at UBS Americas, as well as its global execution and clearing business. Its trading platforms cover a broad range of asset classes, including foreign exchange, interest rate swaps, government bonds, and credit.

Dodd-Frank and Emir have had profound impact on the historically bilateral OTC swaps markets.
“You’ve got a growing acceptance and an increasingly large percentage of the market that is being both cleared and traded electronically,” said Arnold. “An interesting reference point is the market debate between request for quotes and central limit order book. Request for quotes is more pervasive than people thought it would be, because of the bilateral nature of relationships in fixed income markets as opposed to equity markets.”

Given the historic trading ties and bilateral relationships between the bigger buy side firms and the sell side firms, request for quote is still a good way of getting business done. Smaller firms, with less wallet share, as well as new market entrants such as liquidity providers prefer the anonymity of order books. “They think that basically it democratizes the marketplace,” Arnold said. “Whereas bigger firms are still happy to basically leverage off of their brand recognition, and give up names on request for quotes. You’ve got new entrants already beginning to establish themselves in the order book on SEFs. Had it not been for Flash Boys there’d be more of those.”

The buy side is being fairly aggressive in pushing for new ways of doing business. Over time that may well change the nature of the buy-side-sell-side relationship, “especially if you get impartial access; anonymity brings in new participants and clients start trading with each other rather than through investment banks,” Arnold said.

While the buy side’s assets under management have grown considerably, the jury’s still out on whether the buy side will assume the market making role that was once played by the sell side. “It’s pretty clear that assets under management on the buy side now dwarf bank balance sheets,” Arnold said. “However, I do not think that the buy side is a meaningful participant in secondary trading. I don’t think just because the Street carries less balance sheet it means that the buy side is carrying more, all things being equal.”

Featured image via Dollar Stock Photo

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