PUBERTY YEARS FOR FIXED INCOME E-TRADING TOOLS.

Anna Pajor, Managing Consultant at GreySpark Partners.

The technology landscape for fixed income trading is still maturing. Indeed, none of the leading vendors provide a comprehensive suite of technology for all activities that comprise e-trading. However, all vendors interviewed by GreySpark are planning an expansion of their offered functionality.

Electronic trading in fixed income began in the late 1990s. There were a number of factors behind its adoption. In Europe the MTS Group successfully persuaded the majority of national debt management offices to follow the Italian model and introduce a primary dealership system with forced market making obligations on the primary dealers. In the US the largest primary dealers saw electronification of the Treasury markets as a way to reduce their dependence and fees paid to the Inter-Dealer Brokers (IDBs).

In last two years, the development and commoditisation of trading technology for equities, listed derivatives and FX was the main enabler of the shift toward e-trading in fixed income. In 2014, there was an overcapacity of trading destinations compared with the volumes traded*. This overcapacity will be reduced by the increased electronification and the overall change in the market structure, where all-to-all (A2A) venues will gain market share over IDBs and voice trading.

Electronification will continue to erode the traditional voice business. Many market participants expect IDBs to struggle to maintain relevance as Dealer-to-Dealer (D2D) flow potentially moves to Dealer-to-Client (D2C) platforms such as Tradeweb and Bloomberg who offer D2D type capability and who may eventually operate an A2A model with a central limit order book (CLOB). Automation of voice business will be further driven by sales trading automation and the creation of virtual inventory.

A comprehensive technology stack for fixed income trading covers six areas: connectivity; trading; pricing and risk management; sales-trading tools; and e-commerce and client tools (see infographic). GreySpark’s survey of the leading technology vendors showed that none of them has a fully comprehensive suite (see figure; as of 2014). Connectivity is the most mature part of the offering, although it is not yet fully commoditised. This is explained by the fact that the early entrant to the fixed income technology space – ION – is specialised in the connectivity area and set a benchmark for all other vendors. Client structuring and risk tools are the least developed among all trading tools. That relatively low level of development is the reality for all asset classes, not only fixed income.

Connectivity is a ‘cash cow’ for fixed income trading vendors. In 2010 benchmarks showed that the fixed income divisions of the major banks were spending approximately five times as much on connectivity as their equity counterparts due to the high number of proprietary protocols and the absence of a standard such as FIX.

In 2010, the Fixed Income Connectivity Working Group was established bringing together a consortium of leading sellside banks, to initiate a collaborative project to establish industry connectivity standards for fixed income trading using open standards such as FIX and FpML. There were 21 Cash Bond ECNs and 17 SEFs with at least 18 different protocols between them that the Connectivity Working Group was tasked to address, getting them to convert their proprietary APIs to FIX or to promote the FIX API to be equally as performant as their proprietary API.

Not every ECN has adopted FIX as a protocol but enough have that it makes it easier for new vendor entrants to build connectivity tools at a much lower investment. Adoption of FIX is also helping those banks that are committed to getting off vendor solutions, who had a smaller number of gateways, to accelerate their migration. There is an expectation that under MiFID II a large number of aggregators will build connectivity capabilities out and they will do so in FIX.

Another challenge for trading tools providers arose from changing market structure for fixed income trading. The emergence of new trading models is an opportunity to review and rethink the technology infrastructure that supports fixed income trading businesses.

An emergence of new electronic trading venues – for example, swap execution facilities (SEFs) and A2A venues for bonds trading – will require new connectivity, aggregation and distribution engines. The plummeting price of data processing power, combined with the adaptation of data science to improve client services and bank profitability, will also create demand for a new category of analytical tools.

In addition to the challenge to keep up with the shifting market structure, e-trading technology providers should consider the risk of new entrants to the market. Equities and FX trading technology vendors look to differentiate their offering, and an entrance to the fixed income space is seen as a viable option.

Banks are reviewing their platforms on a regular basis, both in-house and vendor solutions. Cost pressures, commoditisation of technology, new markets or business functions, service and stability are factors for banks to consider when examining their platform, and look for alternatives to components, or entire areas, of their trading architecture. For example, uncertainty about the emerging SEF landscape and the leading liquidity venues has delayed decisions within banks on taking vendor solutions and commitments to lengthy contracts. Additionally, the historic monopoly of the biggest vendor on some markets has encouraged dominant banks to keep gateways in-house. However, management of market gateways can become a significant overhead; some markets require more than one gateway and gateways are updated on average twice a year.

The market for fixed income e-trading tools is going through a period of rapid development and change. This is a result of electronification, the adoption of FIX and changes to the market structure. There are at least three more years ahead of us before this part of FinTech industry will reach a plateau. n

Detailed assessment of Fixed Income E-trading tools is available at: https://research.greyspark.com/2014/buyers-guide-fixed-income-e-trading/.

*Trends in E-commerce 2014, https://research.greyspark.com/2014/trends-e-commerce-2014-2/.

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