New patterns in Eurobond electronic trading after MiFID II

March 21, 2018

2559

By Gherardo Lenti Capoduri, Head of Market HUB and Umberto Menconi, Business Development & Market Structure, Market HUB, Banca IMI.

We have come a long way since the Eurobond market was born in July 1963, with the first ever issue: the Autostrade Fixed Rate USD for the Italian motorway network. Then, 1970 saw the first Floating Rate Note, issued by another Italian company (ENEL); and finally, in 1989, the World Bank issued the first Global Eurobond.

In 2013, the Eurobond Market celebrated its 50th anniversary, over which time we’ve witnessed many changes, on all fronts: regulation, primary and secondary market and operational processes.

With the introduction of MiFID II earlier this year, the financial markets landscape as we knew it has completely changed. Directly or indirectly, the rules have impacted the majority of banks’ trading business, challenging their ability to compete in a more globalised environment. Traditional execution models, risk management tools and operational standard procedures are all currently on the table for discussion. Human resources are adapting themselves to the new environment with new skills required on the trading desks, in compliance and in product control. The banks’ organisational structures themselves need to be reshaped in accordance with the actual global landscape, and finally, to meet the increasingly high level of technology within the modern financial markets, IT infrastructure, fintech and digitalisation are increasing their share in players’ capital budgets.

On the 3rd of January, MiFID II started, not with a ‘Big Bang’ as forecast by some editorials by the end of 2017, but instead it all went relatively smoothly, thanks to tremendous work across the entire financial industry in testing the readiness of new systems to meet the new stricter regulatory requirements.

Financial markets are still struggling with some regulatory uncertainties and the lack of data, however, after an initial period where market participants provided only contingency solutions, the picture is now clearer and, even if the fun and games are not yet over, there is still much work to be done in order to establish a consolidated infrastructure, where market players are clearer about what to do and vendors can offer more consistent solutions.

Taking into account the wealth of changes – including the systematic internaliser regime starting in September, pre-trade transparency obligations, best execution reports, post-trade transparency deferrals, transaction reporting, LEI code registration, processed/negotiated trades, research unbundling, cross-border regulation, customer documentation outreach, data mining, and TCA analysis – firms across the buy- and sell side need to take an integrated, holistic and strategic approach. That is equally true of vendors and market operators, if together they are to transform the elevated cost in IT developments into an opportunity.

In the past, Eurobond trading was largely dominated by voice business. The price of bonds took into consideration a number of aspects that are very specific to each instrument, such as funding cost and the repo market among others. There are no historical datasets, no homogeneous measure that enables a standardised comparison of execution quality by counterparties, by venues and by size. As such there is no benchmark as a level playing field to support the calibration of TCA tools.

After 3rd of January in the secondary market there was a shift from voice to electronic business in most of the bond asset classes, mostly due to a mix of efficiency gains, regulatory requirements and IT developments. We shall see in the future if this trend will consolidate.

Faced with the scope of these new market dynamics, banks’ corporate governance has evolved to reflect the centrality of eTrading to their business model, with the aim of overcoming any potential challenge by new market participants coming from the digital economy. The focus now is on:

Technology, with a simplification of the actual infrastructure set-up;
Customer services, with a shift of IT projects from trading models and towards more sophisticated client-segmented services in both high-touch and low-touch and different sales distribution models;
Regulation, which in the future will again be one of the main drivers for process and control of financial innovation – some research has highlighted that the shift of IT implementation from FinTech to RegTech as well as Brexit will not help in the short term.

The key competitive advantage from an e-commerce, global strategic view is the role of data, benchmarking exercises and market intelligence. Now, in Europe, it is very expensive to consolidate trading data coming from APAs, exchanges and ARMs; in fact, the data available are at a disaggregated level and this is the toughest thing in developing fixed income electronic strategies and TCA. Data capture, management, enrichment, normalisation and transformation as well as cybersecurity will play a key role for the future fixed income market and business strategies, as well as more efficient indication-of-interest (IOI) systems, helping a more collaborative approach between the sell side and the buy side, in order to meet their respective requirements and to face the risk of lack of liquidity and market fragmentation.

Market participants need to move from “best” to “smart” execution, adopting a more proactive approach to sourcing liquidity with a multi-asset electronic execution model (fully integrated in their systems), combining an agency-broker model and the consolidated principal-to-principal model through more sophisticated EMS/OMS systems, avoiding operational risk and fulfilling regulatory obligation through fully straight-through-processing.

More so than ever, we may see different approaches, on the one hand by large organisations trying to fit a one-stop-shop with a global approach, while on the other hand we see the niche specialists who are trying to be regional champions for their clients, supporting a less global inventory with a more hybrid-model approach.

Also, the buy-side world is reshaping. The larger asset managers are better equipped to manage the complexity of the regulatory environment and the fragmentation of liquidity; the less structured ones are currently externalising some activities, such as reporting and execution. In the same way, investor protection rules, research unbundling and the new transparency regime are changing the relationship between banks and end investors, with the consequence of forcing – or favouring – the creation of new business models in commercial and private banking.

Most market participants recognise that their MiFID II taskforce will be involved for the whole of 2018 in managing the remediation plans linked to the contingency solutions adopted before the regulation entered into force. However, now they know most of the mosaic and can put together and consolidate each piece of the process.

That will finally establish a new cultural, trading and distribution Eurobond landscape, redesigning their business models and control frameworks, to achieve optimisation in internal processes and to manage the complexity of the new environment in a more efficient way than their competitors.