As europe braces for the impact of MiFID II’s transparency requirements on an illiquid corporate bond market, some traders are at an advantage. A panel of experts led by Italy’s Banca IMI give their view of the value of having already adopted this model.
Luca Bagato, Head of Sales and Business Development, EuroTLX – Luca lectures on Advanced Monetary Economics and International Financial Markets at the University of Piacenza, where he also holds an economics degree. He worked for ten years as a fixed income trader at JP Morgan and Salomon Brothers in London, and spent another ten years as a sales specialist at Citibank and Credit Suisse Milan.
David Bullen, Director, Bullen Management – David now runs his own independent advisory consultancy specialising in Fixed Income market structure and change management. Prior to this David ran Citi group’s global Rates & Credit eCommerce businesses for 14 years.
Gabriele Frediani, Executive Director, Quorum15 – Prior to joining professional discussion organiser Quorum15, Gabriele was Head of Markets at MTS, where he was responsible for the growth of both the interdealer and B2C bond markets and the development of the Repo, Cash and BondVision businesses across Europe.
Gherardo Lenti Capoduri, Head of Banca IMI’s Market Hub – Gherardo started in Financial Control, before moving into Trading at Citigroup. Here he gained extensive experience of both trading and quantitative research, and from 1999 became heavily involved in trading platforms and specialises in online trading, electronic trading platform, and institutional investors sales in both brokerage & execution.
Italy has implemented non-equity trade transparency for years: what lessons can be drawn from this experience?
Luca Bagato: It’s possible to run compliant electronic business for non-equity business and it’s possible to fragment the bond markets – govies and credit – between institutional and retail electronic flows while improving instead of decreasing market liquidity.
David Bullen: We can learn practical and systemic ways that the rest of europe can deal with MiFID
II. Any EU country where bonds were traditionally a favoured investment instrument for the private retail investor will likely be better equipped and set-up than others where equity instruments for whatever reason were/are the instrument of choice for individuals. Given the whole MTS/MOT/ Borsa Italiana/SIA story around bonds from 1999 onwards it does not surprise me that Italy can teach the rest of europe some useful lessons and export some solutions. The difficulties come in convincing people less familiar this is the case.
Gherardo Lenti Capoduri: Italy implemented MiFID reforms in a strict way, particularly in
regard to retail market structure. It anticipated the inclusion of non-equity instruments, which is now of course part of MiFID II. For example, in 2007, Banca IMI launched Market Hub, its multi-asset electronic trading platform. equities, fixed income and listed derivatives were available at the start and FX was added in 2012. In the fixed income space, the bank offers a high-touch service as well as best execution, and access to over 20,000 bonds by connecting to trading venues, OTC liquidity providers and offering additional liquidity on Banca IMI’s systematic Internaliser, RetLots exchange.
MiFID II seems to extend the equity transparency model to Fixed Income markets (and other non-equity instruments). Is it possible? What are the risks?
David Bullen: It may not be possible without severe market impact but I think we’re beyond that now – it will come into force in some form. It risks a completely dysfunctional corporate bond secondary market which is already broken after Basel III/CRD4 impacts. MiFID II pre- & post-trade as currently specified will simply kill it off completely.
Gabriele Frediani: The main consequence of MiFID II is electronification of markets not equitisation.
David Bullen: There is also the risk that some of the untried financial technology (fintech) start up plays will add risk as they may blow up or cause systemic issues given the pace and speed of development disallows proper testing and education.
Luca Bagato: It’s possible that MiFID II could increase transparency for credit markets introducing pre- and post-trade transparency for non-equity instruments but it’s an ongoing challenge due to the split between liquid and non- liquid assets that has to be decided by regulators. There is a risk of confusion between transparency and liquidity, and a risk of fragile market making for institutional buy-side flows.
What are your expectations in terms of players (OTFs/MTFs/SIs) in light of the characteristics of the Italian market?
Gherardo Lenti Capoduri: The respect of the relevant new ‘ingredients’ introduced by MiFID and developed in MiFID II, the flexibility to manage and compare the different types of orders, market models, settlement instructions and client classifications, together with a strong control over the entire execution chain represents the real added value for customers. It enables intermediaries to set up the proper execution policy for the best execution of clients’ orders and the potential to capture greater market share.
Gabriele Frediani: There are many different market protocols in the Italian bond market which shows that the ‘one size fits all’ is the wrong approach. With threats come opportunities and there are lessons to be learnt from Italy’s various solutions including euroMTs, BondVision, euroTLX, MOT but also Market Hub, a true pioneer in this space. some are applicable elsewhere in both rates and credit. An often forgotten factor behind the healthy liquidity of the Italian bond markets is the liquidity of its repo market, at least in the government bond space. Again participation goes beyond pure inter-dealer.
Luca Bagato: EuroTLX’s bond trading experience is a good example of a technological and resilient electronic platform that can be present as a domestically-born and exportable trading model for retail and odd lots trading activity. especially for credit and liquid long-end emerging market bonds in europe.
How might bond trading evolve in terms of market model and structure?
Luca Bagato: We are expecting more electronic business, especially for credit markets which will also involve buy-side trading for odd-lot purposes. Also we are expecting more retail investors trading flows and increased business activity with medium-size asset managers and bankers over all european electronic trading venues.
Gherardo Lenti Capoduri: New solutions are in the works. some intermediaries are developing smart order execution tools to take in – in the same execution policy – traditional markets and OTC and to compare different execution models – request for quote (RFQ), central limit order book (CLOB), voice, etc. Concepts such as large-in-scale orders and products such as ‘order sweeping’ from one execution venue to another are also being developed.
A virtual book, composed of the bids and offers, coming from different venues and market makers, would be the best instrument to consider. Consistent with the idea that there will not be an execution model winner, Banca IMI has developed its RetLots Pit non-systematic internaliser solution that is already active and is moving forward in the direction of integrating OTCs versus traditional markets.
We do not believe in a real equitisation of fixed income markets. However, due to the enormous number of bond issues and most strict capital requirements, we would expect a sound shift from a pure proprietary trading model to a hybrid approach, based upon own proprietary market making and an agency model.
Do you expect newcomers? Do you expect more development for multilateral venues (OTFs?) or bilateral trades (SIs)?
Gherardo Lenti Capoduri: Yes, it‘s most likely that new players will enter this arena. The IT infrastructure will gain more and more importance and become more strategic in the financial markets, especially regarding fixed income OTC trade execution. Therefore dealers must also have sound IT skills in order to manage their brand new tools. On the other side, due to the intrinsic nature of fixed income markets, sIs or a web of sIs will play a primary role. OTFs seem to be more appropriate to OTC derivatives like Us seFs.
David Bullen: There will be many buses at the bus stop most of whom will break down or disappear or take a wrong turning before getting their passenger to their destinations. I expect most of those that do survive and succeed will have been incumbents or dominant players in some pre- existing space before these regulatory changes. either that or they will innovate. Italy has some major pre-existing players. If they innovate, expand and adapt their style and messaging to other market practises I would expect them to have a good chance of succeeding.
How could new transparency rules affect liquidity?
David Bullen: Greatly. If you know everyone knows you just bought an illiquid bond and you are a market maker with a finite balance sheet you simply won’t do that business anymore, so what liquidity there now exists will be gone never to return.
Gherardo Lenti Capoduri: The risks related to a wrong calibration of the transparency rules together with a more and more fragmented market environment might affect fixed income market liquidity for some financial instruments/markets and lower levels of order execution. More efficient intermediaries have tried to mitigate the issues by offering customers an integrated book with one or more levels of prices, according to the relevant trading venue, during the pre-trade phase as well as smart order management systems that can dynamically direct the order to the best venue according to MiFID criteria, properly weighted in the post-trade stage. One of the main problems though is that market data sources throughout the trading cycle have become increasingly expensive and would benefit from a consolidated pan- european tape for post-trade.
Gabriele Frediani: Generally speaking, and beyond Italy, because of reduction in balance sheets the trend of less active banks, with fewer means and less risk appetite will continue to impact quality and quantity of liquidity. The challenge is for other participants with other protocols and venues to fill this ‘animation’ vacuum. I believe that Italy is ahead of the curve, but for how long?