By Chris Jenkins, Managing Director at TORA
Bond markets are solidly on a path towards joining foreign exchange and equities in being a primarily electronic market. It’s been a decades long journey, but one that is now gathering pace. Greenwich Associates, a consultancy, reported that globally 35 percent of investment grade and 25 percent of high yield transactions are now handled electronically.
As reporter Robin Wigglesworth recently wrote in the Financial Times, “Fixed income markets have historically been overwhelmingly analogue. Some corners have slowly been dragged into the modern, digital era of trading — the bigger, more homogenous and liquid government bond markets especially. But, on the whole, trading has long stayed bilateral, bespoke and arranged by phone or Bloomberg messages.”
With momentum on the side of electronification, the question becomes how to make further progress: ideally the markets should be as close to 100 percent electronically traded as is feasibly possible. Here it is important to understand the “two markets” that now exist inside the bond market. One market comprises the more liquid parts of the market, such as sovereigns and blue chip corporates. Finding individual securities here are easy to source, easy to trade and easy to process. The other market is the area where more focus needs to be paid. These comprise munis, small corporates and three-quarters of high yield trades. These are hard to source, more difficult to trade and comprises more manual post-trade functions.
Creating the necessary conditions is the responsibility of all market participants. Regulators need to provide clarity, guidance and publish their forthcoming regulatory roadmap. The buy-side needs to further develop all-to-all trading in order to directly trade (with protocols to protect information leakage) with many bond investors and not just a handful of dealers. What’s more, then there are technology providers, who can open up possibilities through innovation.
Here are three ways vendors and consultants can support increased electronification of bond infrastructure:
The importance of better predictive tools
The market needs instruments that can help traders find needles in a haystack of liquidity through algo and machine learning. AI and algos have become a major feature of low-touch trading, freeing human resources for the high-touch, complex trades on the blotter. Every step-change on the technology side improves the efficiency and value of the traders who were previously focused on voice trades.
Fixed income TCA for better understanding
Transaction cost analysis is widely used by major equity desks to provide reliable metrics to benchmark trades. First, this was only available after the fact, but advances in technology mean that pre-trade TCA is now being deployed. Its continued deployment across fixed income desks can give more granular analysis and make it clear which trades in more opaque parts of the market may be profitable.
Better communication throughout the market
The bond market is more diffuse than other parts of the market, without a centralized exchange and thousands of different instruments. Electronification is only possible through better internal and external connections to other market participants to smooth system gaps. This is taking a role that used to be played by a small network of traders on phones and turning into something completed through digital communication and APIs.
This isn’t an impossible task; in some parts of the market the majority of bonds are traded electronically. Government bonds are the most liquid with around 64% of US Treasuries now trading electronically, and other G7 government markets such as Bunds not too dissimilar. But the brokers and buy-side will need help in order for this to happen. There’s a meaningful role for vendors such as TORA to play in part of the development of the overall asset class infrastructure discussed in this article. Their efforts are a meaningful part of why we believe we’ve seen strong growth in the past few years. The success of continued electronification shows encouragement from analysts, regulators and most importantly market participants to help build together the bond market of the future.