By Flora McFarlane.
Analyst firm Aite Group has predicted six electronification trends for fixed income in 2018, highlighting further room for expansion for fintech firms, an expected increase in the role of non-traditional market participants, as well as commercial opportunities deriving from MiFID II.
The trends forecasted to have an impact on fixed income market participants are:
• Venues and supporting technology will continue to launch;
• More trades – particularly in less liquid securities – will be traded electronically;
• More pure fintech firms will enter the space;
• Nonbank liquidity providers will expand their role;
• MiFID will foster substantial changes in transparency and workflow;
However, report author, Audrey Blater, stresses the need for “true fundamental changes” in transparency for an improvement in bond market liquidity.
The ever-expanding number of electronic bond trading venues is expected to grow, with entrants able to offer more automated trading options, and developing new methods to foster liquidity, automation and efficiency.
Recent research from Liquidnet, surveying global asset management firms representing US$13.1 trillion in AUM, supports this; it found 63% of respondents are planning to switch to greater automation, accelerating an evolution in electronic trading.
Fintech firms are also set to continue to enter the fixed income space. Aite Group reports that these firms are able to offer price-discovery solutions that can be integrated easily; facilitating post-trade requirements efficiently, as well as regulatory compliance.
Notably these fintech offerings are not all rooted in fixed income, despite high entry barriers, with some applying expertise in FX and equities to corporate bonds.
The Liquidnet research also shows that use of fintech is set to increase, with 83% of traders looking at venue initiatives to incorporate in their workflows and firms increasingly moving a greater proportion onto platforms.
Aite Group however also notes the activity of exchanges and bulge brackets that are striving to automate their solutions by building in-house technology or partnering with third parties.
The shift in dynamic between traditional market-makers and nonbank liquidity providers is another notable trend that is expected to continue in 2018.
Thanks to the vast swath of regulations post-crisis, as well as constrained bank balance sheets, the fixed income space has seen buy-side firms acting as market makers, and electronic venues augment liquidity and price discovery.
Regional dealers and inter-dealer brokers have also been able to take advantage of the changes.
The US$8.4 trillion US corporate bond market is also expected to feel the effects of automation. Despite advancement in retail and smaller institutional flows, 75% to 80% of corporates continue to be traded by voice.
Aite Group describes the “corporate bond iceberg” as comprising of two tiers. The first, retail volume and exchange-traded funds, deals with an ostensibly fully automated process of trade sizes smaller than US$100,000. These are mostly transacted on platforms offered by TMC Bonds, ICE’s BondPoint and Tradeweb.
The second, more complex tier, is more diverse; trades range from larger retail and institutional odd-lots to buy-side flows less than US$2 million.
While existing offerings from firms such as MarketAxess, Tradeweb and Bloomberg cater to these trades, the report highlights this as an area for growth. “Newer innovations, including all-to-all connectivity, also focus on enhancing liquidity to this portion of the market.”
One respondent in the Liquidnet report, however, said: “18 months ago we were 100% voice – already we are trading 30% of IG and HY electronically, but electronically arranging trades and meeting on venue has gone from 0 to 10% of our flow in less than a year.”
The impact of data is a recurring theme through the Aite Group report, and the data opportunities from MiFID II are significant.
The discovery and development of data-centric solutions is expected to accelerate, creating opportunities for a wide range of commercial solutions in areas such as risk assessment, business intelligence and audits.
Blater notes that in 2018, thanks to MiFID, firms have taken a more holistic approach to their business models, turning to new technology rather than trying to make existing legacy solutions work.
“Many market participants have opportunistically invested in additional technological resources to become more efficient.”
The report warns, however, that greater automation and electronificiation of the fixed income markets will not solve the liquidity issues in the corporate bond market.
With European corporate bonds representing just 10% of GDP versus 31% in the United States, any initiatives that improve the functioning of the market will ultimately offer better investment opportunities to investors.
The Aite Group report concludes that the market must attempt move towards transparency, ultimately meaning that a data renaissance is more important for the corporate bond industry than electronification.