INTEGRITY COUNTS.

In a market of proliferating electronic trading venues, Michael Krogmann, EVP at Deutsche Börse AG, explains why they may have a platform in Xetra Bonds that will stay the course.

Why do you think bond trading has to shift from OTC to regulated markets?

Bonds as an asset class have become much more popular with investors and they have significantly gained importance on a macro-economical level. As a result of the financial crisis, governments and companies alike were forced to look for re-financing alternatives. This continuously growing prominence has not been reflected by the traditional bond trading places. Telephone- or “request for quote”-based trading simply lacks the transparency and the efficiency an asset class this important requires. After all, investors are confronted with unclear prices and high risks. Thus, transparency and market integrity in bond trading are absolutely necessary. In two years’ time, it will be mandatory anyway, due to the transparency requirements which will come into effect with the implementation of MiFID II. In addition, CRD IV (Basel III) increases capital requirements for dealers. Hence inventory based liquidity provision becomes more expensive – another reason for a shift to organized electronic markets.

How would you try to convince market participants to change their traditionally OTC-bound bond trading activity?

The same way you always convince ration people: by showing them a superior alternative, by making them a better offer. Deutsche Börse has done exactly this by introducing Xetra Bonds. This new product segment on Xetra aims to provide investors with exactly the market quality and standard for bond trading they expect – and rightfully demand – from equity markets. In OTC trading, market participants have to request quotes from several banks to assess whether they get competitive pricing. In bonds, they have no access to continuous real-time pricing. Xetra Bonds, however, offers real-time price discovery via an open order book with a depth of no less than 5, meaning the five best bid respective ask prices will be depicted. Therefore, investors are able to enjoy best execution of their bond trades exactly as they do when trading equities or ETFs. This way, they can be sure they are getting a competitive price, especially since they trade under the same conditions as every other market participant. Xetra Bonds provides every market participant with a fair, identical and anonymous access, as required for regulated markets.

In a nutshell, this is our USP – we offer more transparent and fair pricing than any OTC trading facility, thus promoting a market integrity bond trading has not experienced before.

A better offer usually means a better price. In this respect, why is your new offering superior to other recently established platforms?

There are several factors which set our new offering apart from those of our competitors. Let us talk transaction costs first. Explicit transaction costs in bonds trading on Xetra are very low due to a highly attractive pricing model and the efficiency only straight-through processing on a fully electronic and sophisticated trading platform can offer. However, explicit transaction costs account for not more than 20% of the overall transaction cost. In the end, it is implicit transaction costs that determine the price of a transaction, which fully depends on the liquidity in the respective bond. The Xetra Bonds market model ensures the highest possible liquidity and, therefore, the tightest spreads and considerably lower trading costs. The trading model – comparable to the trading of blue chip equities – is supported by designated sponsors who provide continuously binding quotes for the 60 German government bonds in this product segment. We are talking bid-ask-spreads which today can be as tight as three basis points.

In addition to our offering of German government bonds the Xetra Bonds segment includes 2,000 of the most traded European government, supranational and corporate bonds. The trading of less liquid bonds is based on a continuous auction model supervised by so-called Specialists. These Specialists provide indicative quotes and additional liquidity where and when needed. This way, they are able to make less liquid bonds as tradable as liquid ones, making sure the majority of the orders will be executed at competitive prices and the tightest spreads.

Another important factor is the elimination of counterparty risk. German government bonds are settled by a Central Counterparty (CCP) in Germany, bringing more safety and efficiency to settlement in Europe.

What else does the Xetra Bonds segment bring to the table?

Something that cannot be quantified like transaction cost but nevertheless is very important: Xetra Bonds is future-proof, especially in the light of increasing regulatory requirements regarding pre- and post-trade transparency. Bond trading on Xetra not only complies with current regulations but already today reflects the transparency requirements by the revised European MiFID directive that is expected to become mandatory within the next two or three years.

Let us talk about a different aspect of bonds – the issuing side. What can your exchange offer to companies wishing to list their bonds?

For that very purpose, we have introduced an exchange segment for bonds with a variety of transparency standards for companies. Thus, companies wishing to raise their profile and to increase their visibility among potential investors can list their bonds in the newly created Prime Standard. Fulfilling the highest transparency requirements, they will be able to address institutional investors all over the world and gain access to a broader and more direct distribution channel to private investors for the first time. This new segment appeals to larger companies – listed or not – that wish to place bonds from a value of EUR 100 million. After the successful introduction of the Entry Standard for bonds for mid-sized companies in 2011 the Prime Standard was only a logical extension.

How do you expect Xetra Bonds to perform in the long run?

Realistically, it will take some time but I am confident Xetra Bonds will attract – and hold – a significant share in overall bond trading over the next few years. After all, Xetra is a leading pan-European market place and the trading platform of choice for 250 European banks and broker firms in 18 countries. I am sure many of them will appreciate our new bond offering tailored for investors’ and issuers needs. A major boost in interest for Xetra Bonds will be the forthcoming regulatory changes by MiFID II in 2015.