The longstanding debt market in Italy offers a good source of insight into the impact of changing rules around best execution and transparency in the European market. Tullio Grilli, head of bond brokerage at Banca Akros explains what we might learn from the Italian experience in achieving best execution in all asset classes of bonds.
How would you characterise the Italian bond market in terms of instruments and structure?
In Italy there are currently one regulated market, three multilateral trading facilities (MTFs) and around twenty systematic internalisers (SIs) which are primarily used by retail operators; there are also two regulated wholesale markets where government bonds are mostly traded. The range of activity seen amongst institutional and retail investors is very diverse in terms of the types of bonds traded, and it is also very intense.
What changed in the market when MiFID came into effect in 2007?
With the introduction of MiFID in November 2007 buy- and sell-side firms had to take on board the principle of best execution, which in Italy meant that even the less sophisticated operators needed to get access to the largest number of execution venues possible. In particular the ability to access less transparent execution venues, and their typically indicative quotes, reached by sending requests for quotes (RFQs) has become a growing need.
How did brokers adapt to this change?
Most Italian bond brokers have evolved accordingly. Some brokers offer a ‘static’ best execution solution selecting – for each bond or asset class – the reference execution venue where the routing of client orders go. Others, conversely, are offering a ‘dynamic’ best execution solution. Banca Akros, in particular, developed the first Italian smart order router (SOR) for bonds which is able, among other things, to obtain dynamic best execution for each category of bonds thus automatically generating competition between a large number of execution venues in all the categories provided by the MiFID directive. Our SOR, called ‘Sabe’, started operations on 1 November 2007.
What were the effects on the point of execution e.g. trading venues and liquidity aggregators?
The smart order router has over time become the most effective and technologically advanced solution that is able to meet the requirement of dynamic best execution. It is able to aggregate liquidity provided by a variety of execution venues, making their prices completely comparable. Since it has been in operation in Italy new execution venues have emerged and become established, mainly MTFs and SIs. They are often characterised by different market microstructures, often being order driven.
How were order routing and transaction cost analysis managed in this environment?
Dynamic best execution, in this new context, means that for each execution venue Sabe has to calculate the total consideration given by the sum of the execution venue price and the cost for accessing it. Other elements such as execution venue reliability and its access / response speed are usually considered secondary unless specific execution policies say otherwise.
Are there lessons that can be learned from the process, regarding price and liquidity discovery?
The price discovery phase assumes an increasingly important and strategic role, becoming the key phase in the global, dynamic best execution process. Price dissemination, price access, price reading and the possible standardisation of all the relevant information become fundamental elements in the process of evaluating and measuring the quality and competitiveness of the execution venues themselves.
What can a buy-side trader take from the Italian market when looking forward to the European market under MiFID II?
The focus on pre- and post-trade transparency, and the order-driven microstructure that facilitates the matching of bid and ask prices gives the buy side the opportunity to participate actively in price formation in the market. The emergence of systems that ensure and demonstrate the achievement of dynamic best execution through competition between execution venues with different characteristics and properties also represents a peculiarity of the Italian bond market that should be carefully taken into account by traders.
How do you see the role of the sell side changing over the next three years and how will that affect service for the buy-side?
The introduction of pre- and post-trade transparency rules and the split of securities into more categories / classes, based on their level of liquidity, may force the sell side to review its strategies and techniques in the quoting of bonds as well as the universe of securities of interest. In this scenario, the ability to price bonds, already heavily penalised by stricter regulations and higher capital costs, could be further constrained. In the coming years it is also possible that the role of the sell side could change dramatically compared to today and no longer be the main reference point (and in some cases the only reference point) on trading bonds.