Larger dealers to benefit from bond electronification

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By Vineet Naik.

Despite market volatility and regulatory pressures, there is stability at the top of the global fixed income market, reports analyst firm Greenwich Associates in the statement accompanying the 2018 Greenwich Share and Quality Leaders in Global Fixed Income.

Europe in particular has had more to deal with than uncertain markets and tentative investors, says the report. Changes in the market structure and regulation including MiFID II has affected the way the market operates.

“[The consequence may be a market with] fewer players, less liquidity and increasing market concentration,” according to Satnam Sohal, principal at Greenwich Associates.

US banks have also had to work through market and regulatory changes, investing in technology in order to stay compliant with the new regulatory environment, as well as to provide added insight and analysis to their clients. Some dealers are increasing focus on “middle market” investors – businesses with revenues in the US$10 million to US$1 billion range – in order to expand revenue pools.

Even though 2018 was a weak year for global fixed income in APAC due to US rate hikes, Chinese deleveraging, and the trade war, global banks continued to invest in the market due to fast growing Chinese bond market, as well as China based investors.

The report makes clear that the role of technology will continue to grow in importance within the fixed-income business, which will favour the bigger players due to the capital-intensive nature of this model. The reality of the downward pressure on fees due to technology will also end up rewarding the largest dealers and investors who can utilise economies of scale.

However, the proliferation of technology usage across the board could also provide greater access to liquidity providers and therefore create pressure to tighten spreads.

“From an investor’s perspective, trading electronically takes away some of the barriers in Europe such as the jurisdictional ones, and will result in a broader range of dealers covering the market. On the banks side, they need to be more aggressive in pushing their liquidity on the platforms,” said Sohal.

In terms of the sorts of technologies being applied, “All-to-all keeps coming up,” says Sohal, “and there is growth, but it is not clear how much of it is coming from buy-side to buy-side trading, versus from banks in the back offering liquidity.”

There have also been differences in the shift to electronic trading between instruments. “Rates have been the most electronic. When the swap execution facility (SEF) mandate was introduced there was a big shift in swaps, going from 20% electronically traded to 60%,” Sohal says.

On certain products, as clients are getting used to trading electronically, they are getting more comfortable with trading in larger volumes. “Now, we are seeing clients happy to trade US$10-20 million dollar sized blocks in government bonds electronically.”

Even amongst the world’s biggest fixed-income dealers, most are responding to the current environment by focusing investment on products and markets in which they have a competitive advantage or where they have the best profit potential. Regional specialists and smaller players will maintain niches, but there is increasing business concentration at the very top, which is predicted to continue and intensify with MiFID II and as technology takes a bigger role.

“Clearly the banks that have invested in technology will benefit from this shift towards electronic trading,” says Sohal.

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