The US Treasuries market is changing. Electronification has permeated almost every step in the trade lifecycle, enhancing efficiency, cost-effectiveness and risk management capabilities across the front, middle and back offices. Perhaps even more noticeably it has, to a large degree, been a facilitator in spread compression. But when it comes to the critical moment of execution, many electronic platforms hurt the very participants they seek to benefit.
Both the dealer-to-dealer (D2D) and dealer-to-client (D2C) worlds face the challenge of market impact, albeit across differing models. Consider the D2D central limit order books (CLOBs), where order and tick data is consumed by technologically sophisticated firms at incredibly high speeds. The net result for the liquidity consumer, particularly when venues are co-mingled into a single aggregator of liquidity, are poor fill ratios because of order and execution actions, creating a large footprint in the market. Even if the price granularity being offered by the platform looks favorable at first glance, is it worth the risk that a competitor will leverage high speed market data to capitalize on the information you have just made public?
The D2C market is no different. Youre in the market to purchase a large lot of on-the-run 10-year. You go to your RFQ-based electronic trading platform of choice – typically the one that offers the tightest spreads or best response rates – and submit your request to five different dealers. You have immediately revealed your hand to multiple counterparties, only one of which you will end up doing business with. The other four have received highly sensitive insight into your trading intentions for no cost, and without ever having to provide liquidity.
The impact of this is not just limited to the buy-side participant in this example. The market maker that wins the RFQ has also revealed the size and side of the trade to its four competitors, presenting a considerable risk that they will subsequently use this information to gain an advantage in the market. Can either party justify the inherent risk in this trading model simply to save a few dollars on the spread?
Clearly price is a critical factor in any decision when it comes to choosing an execution venue, but participants have started to realize that there is a greater underlying issue at play. The trading models that were accepted as the status quo in the past are not necessarily appropriate in a market that has, for better or for worse, learned how to use them to gain an advantage.
In the US Treasuries market, for the first time in generations, traders have access to a growing range of trading protocols that allow them to break free from the RFQ and CLOB models. And while platforms facilitating these incumbent models continue to try to attract business with marketing tactics such as increasing price granularity, there is an undeniable trend taking shape.
The appetite for more choice is clear and – as in any market – with more options, participants can base their selection of platform on a far greater range of factors rather than simply price alone. Participants now have the option of accessing liquidity directly from dealers through bilateral relationships, via electronic multi-dealer platforms supporting a variety of execution protocols and customization, or ATS trading portals.
A model that is gaining significant traction in US Treasuries bears many similarities to the framework of todays FX market, whereby participants on all sides are interconnected on a streaming peer-to-peer network.
Critically, the peer-to-peer model allows all types of participants to interact and trade with each other, leading to providers comfortably showing larger sizes and tighter prices, while eliminating the risk to the market maker of revealing sensitive information to its competitors if it wins the trade.
At LiquidityEdge, our private trading network minimizes information leakage and market impact by publishing data only to the participants of the trade, and enabling them to customize price streaming amongst a known and trusted network of counterparties. No market data is published, so the opportunity for gaming and toxic trading strategies is eliminated, and participants still benefit from extremely high fill rates alongside the tightest prices in US Treasuries.
New models such as these have been developed specifically to help participants adapt to the current trading environment in the US Treasuries market. The platforms that were accepted as the norm in previous years simply are losing their fit-for-purpose tag, and pricing strategies that might seem compelling at first glance are typically attempts to bandage and disguise underlying wounds that refuse to heal.
US Treasuries market participants stand on the cusp of a brighter future. The growing popularity of the peer-to-peer model is cultivating a healthy, thriving trading ecosystem in which both liquidity providers and consumers benefit from greater efficiencies and, ultimately, a sustainable increase in revenues based on more than simply price granularity alone.
As they say, price isnt everything.
Tim Cook is Head of EMEA & APAC Sales at LiquidityEdge
