Last week I attended FILS, an excellent event organized by Henry Wallis, Oliver Kirkbright, & Co. bringing together the good (buy & sell side + liquidity venues), the bad and the ugly (incumbent vendors :) ). It was a welcomed reprieve for embattled Fixed Income traders, enabling them to forget about market volatility for a few days.
There were a number of interesting trends and themes discussed – I’ll describe what I heard and opine on them a bit below.
o Tighter liquidity from the sell side due to new capital requirements
o Market transparency – TRACE (Trade reporting & compliance engine)
o “Electronification” of Fixed Income trading
o Emerging execution patterns (all-to-all, pre-trade indication)
o Success factors for SEF / ATSs to survive and thrive
o Liquidity fragmentation and the logistical challenges it implies
Re: Regulation - Like bad-tasting medicine…
- Nobody enjoys its first order consequences (added cost and complexity for doing business)
- But speakers and attendees did attach to its longer term goals (market stability, less systemic risk, investors confident in “the system”) as long the implementation path was collaborative and not overly prescriptive.
- There were differing opinions on TRACE’s impact on liquidity. I could have done without the excessive repetition of hollow and obvious mantras like 'equitification of fixed income' and 'Equity is different than fixed income'
At Adroit, we love microstructure transparency.
- TRACE is far from that but, in exposing reference prices from the recent past, represents a step in the right direction.
- Naïve players mistaking it for something more will get burned.
- TRACE will also hurt players whose business models rely on inefficient markets (think of 'relationships', soft-dollars, with investors directly or in-directly paying the cost for market opacity).
- There is no substitute for understanding the market micro-structure in a first principles way to come up with target/acceptable execution pricing levels.
Re: FI Trade Execution - The buy-side perspective: “walking up a down escalator”:
- Despite a maturing market with increasing transparency, the buy side can’t easily capitalize on these advances to improve trade execution
- It is becoming more of a logistical challenge to find liquidity in Fixed Income markets (shrinking sell side balance sheets, fragmentation of liquidity channels)
- Vendor technology hasn’t kept pace with the evolution of the market; as a result, complexity gets propagated to end users (investment managers) and they either live with sub-optimal execution or spend a lot of time and energy solving for the added complexity.
- We expect more liquidity models will emerge. For example, one can envision liquidity provided in Dv01 terms, almost like CDS where 'any eligible bond' will do.
Implications of the evolving marketplace for the buy side:
- Traders (or their tools) will need to engage in instrument selection and ‘smart order routing’ to venues.
o Either execution traders will need to relay market conditions to PMs that will influence instrument selection (impractical and burdens PMs with logistical details they’d generally prefer to delegate)
o Or they will need to be provided target exposures (e.g. in DV01 terms and/or key rate durations) and afforded some creative license and degrees of freedom to find the best execution strategy (instruments, venues, etc) to implement the target exposures at lowest cost.
o Trading strategies will quickly evolve towards 'exposure trading' as opposed to looking for specific bonds/instruments.
Need for advanced Liquidity aggregation
o Normalize, aggregate and act on liquidity across various providers and models (RFQ (voice & electronic), Orderbook, All-to-all, published dealer inventory, axes)
- Need to continuously evaluate related markets
o To ensure there is no 'standards arbitrage' (e.g. par vs. MAC swaps) and ensuring dealers are not charging excessively for customization
- Need for decomposing desired exposures into standard instruments (lower execution & maintenance costs) and custom instruments for any residual target exposure
- Need to continuously evaluate and take advantage of package trading opportunities
o Using bond lists, rolls, compression services and comparing these opportunities against other options (outright, stripping a package into standard and odd residual exposure)
- TCA is evolving beyond bid-ask spread and two-way quotes from multiple dealers
o Dealer scorecards must go beyond simple transaction costs and firmness of quotes in the primary execution channel (e.g. bigger picture view of different trading and liquidity models)
o Anticipating and decomposing the sell-side pricing model: Understanding the motivation, hedging and related markets used by sell-side to quote a price. This pricing model reverse engineering will allow for rational tradeoffs between using standardized OTC products and highly customized products (and weighing this vs. any operational efficiency gains/losses).
o Interpreting more and more data from diverse sources. Data will increasingly be transparent and available, liquidity providers and venues will compete and differentiate themselves by providing that data.
Some additional highlights that made my trip to Boston worthwhile:
- Christopher Voss on how the skills he developed as the FBI’s Lead International Hostage Negotiator are relevant to Fixed Income trading and regulation – I never doubted the relevance :)
- Paul Hamill presented Citadel Securities’ vision that I believe will have them eating everybody else's lunch (as they often do)
- Billy Hult on how Tradeweb plans to stay ahead of the competition. As the leading incumbent, it will be interesting to see how it plays out and whether they can avoid the perils of the “Innovator’s Dilemma”
- Hicham : Always insightful.
- Zack : I wholeheartedly agreed with his assertion that, 'You need to hire smart people to figure out intelligent trading process'.
- Susan Estes : Her command of Treasury markets and its data was impressive.
- Kevin McPartland : Intelligent, witty and quick – is he available to moderate the Clinton / Trump debates?
- Chris White : did a wonderful job picking out the most germane threads from the panelists’ ruminations and used them to drive the conversation in the most interesting directions.
I am sure I missed many notable speakers and sessions. Some focused on areas beyond my pay grade (e.g. 'Global interest rate trends') :)
Plug: We at Adroit are well on our way to solving the buy side’s predicament in Fixed Income trading (and beyond).