Umberto Menconi, head of Digital Markets Structures, Market Hub, Intesa Sanpaolo Group explains how a consolidated tape (CT) will help agency brokerage desks provide best execution strategies for clients in fixed income.
Fixed income securities are typically traded in over the counter (OTC) markets, through the traditional client-sales-trader workflow and, even if it has been rebalanced in the last year towards alternative trading solutions (e.g. Click-to-Trade, CLOB, All-to-All, etc), the multiple request for quotes (RFQs) will continue to dominate as the primary protocol. Although it has generally been recognised that this is the best performing model for trading fixed income, there is a general perception that it contributes to generating an uneven information playing field, due to market data leakage and the opaque nature of fixed income trades. It is not only the amount and type of information that varies across market participants, but also their capability to process data and quickly turn it into trading decisions.
Fixed income market fragmentation has also exacerbated data asymmetries, due to trading data dissemination across multiple venues and Approved Publication Arrangements (APAs), discouraging new market participants and cross-border investment. Hence, only a few players are able to have a comprehensive overview of fragmented market liquidity, through automatic consolidation of market data in a virtual book composed of multiple quotes. Meanwhile, smaller players in general do not have the economies of scale to make such investments worthwhile, and rely on brokerage firms and their data analytics capability as well as Smart Order Router solutions to access multiple venues.
The need for market data “democratisation” – high quality and reliable data sources, trustworthy standards, supplied in a machine readable and easily accessible format – drew the attention of the European authorities, regulators, trade associations and the industry towards the creation of a European Consolidated Tape (CT), the aim of which is to provide all investors with a comprehensive and standardised view of European trading volumes, in line with the European Commission’s vision of a Capital Markets Union.
How could a consolidated tape impact execution quality in bond markets?
A CT, provided it is made available at a reasonable cost, can bring great benefit to European fixed income markets and also help in levelling the playing field for retail investors. It would increase their market confidence and trading participation, even if it cannot present a panacea for market inefficiency, the illiquidity dilemma and the cost of market data.
A realistic and widely supported approach to the creation of a bond CT starts from MiFID II’s post-trade data collection. Therefore, while the consolidation of post-trade data can be valuable for market insights, pricing models, transaction cost analysis (TCA), and best execution performance assessments, the impact on pre-trade decision-making, on price discovery, on algorithmic trading and on best execution smart order routing is less evident, and either does not represent a substitute or cannot compete with venues’ real time price offerings.
The implementation and consumption of a CT does not require a change to best execution rules: agency brokers should continue to be allowed to have discretion about which venues to access when executing clients’ orders, but, through the CT, agency brokers may compare their execution strategy with a calculated market benchmark in order to evaluate the quality of clients’ order execution, and to provide support to periodic best execution reviews.
Which challenges might it create post-trade, and how could those be overcome?
Post-trade, fixed income market data is currently scattered across multiple venues and APAs, which makes aggregating data extremely challenging. Difficulties in accessing ‘public’ websites, a lack of consistency in formatting, technical delays, consumption costs, information asymmetries and data errors all contribute to these challenges, which could be overcome with the creation of a fixed income CT. The technology required to consolidate market data in a single tape is not considered as a constraint. Rather, the challenges faced in the creation of a CT are structural, organisational and economic. Factors include post-trade deferrals harmonisation, the CT governance rules, the definition of a comprehensive data set, the consumption utility cost model, mandatory data submission versus non-mandatory consumption, as well as the definition of a reliable data cleaning process to avoid database inconsistency and duplication, and the respect of high quality data standards and to an appropriate level of latency.
In a more transparent market, what might be the effect on the risk management of positions for market makers?
In fixed income markets there is a general consensus that the wrong calibration between liquidity and transparency is detrimental for market makers’ inventory, pricing capacity and hedging activity, discouraging dealers from trading orders, especially in illiquid bonds and in large size. For illiquid instruments and larger size trades especially, when the buy side relies on market makers as the only source of liquidity, prices can be extremely sensitive to information dissemination. Post-trade transparency, incorrectly balanced with liquidity and trade size, may create risks for both liquidity provider and liquidity taker and can be detrimental for overall market spread levels and ultimately for clients’ orders execution quality. From another perspective, a good calibration may attract other players to the fixed income markets, who might otherwise stay out, and effectively provide more liquidity and more competition.
What value would it add to the services of an agency broker, as opposed to a risk-taking market maker?
A consolidated overview of fixed income markets’ post-trade data through a CT can improve not only best execution assessments and TCA, but can also support brokers’ development of multiple services for clients such as regulatory reporting, portfolio valuation analytics, order monitoring and surveillance, benchmarking services, decision-making assistance, price discovery, market insights to end-investors, buffering market volatility, as well as other operative solutions based on artificial intelligence and machine learning.
The capacity to offer new services shifts brokers’ attention from pure execution and raw post-trade data towards a more sophisticated and enriched client experience. This enables investors to assess more accurately current market dynamics, increasing overall investor confidence, particularly during times of market volatility.
Which questions should buy-side firms be asking of their brokers, regarding the development of the CT and CTPs?
In the absence of market data consolidation, investors must build their own view on the liquidity and trading opportunities across fixed income markets. Fragmentation and asymmetry make it very complex especially for smaller firms.
The creation of a CT, available at a reasonable cost, managed by a single CT provider for each asset class and with high quality standards, may help data democratisation and market transparency, enabling the buy side to assess current market dynamics more accurately. More transparency increases overall investor confidence and control over trade execution, facilitating a closer collaboration between brokers and clients.
Our key proposition in the fixed income space is Market Hub PIT, a trading solution fully integrated with Market Hub multi-asset agency, orders execution policy. Market Hub periodically monitors the best execution strategy, not only for MiFID regulatory purposes, but also for strengthening the quality of clients’ orders’ execution and, by extension, improving client relationships. Technology to collect consolidated data and to analyse it is actually available and reliable, but the industry needs data to feed execution models and monitoring tools. By analysing and comparing market data provided by a CT, it may be easier to detect inefficiencies in the execution strategies, assess which venues would have represented a better choice for a specific deal, order size and instrument and integrate them in order execution policy, thereby reducing clients’ operational complexity and the impact of fragmentation.
The author would like to thank Lorenzo Bracchi for his collaboration in writing this article.
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