Carl James, Global Head of Fixed Income and FX BNP Dealing Services and Managing Director of Dealing Services UK looks at changing technology, and changing skills, on the buy-side desk.
In the past, when trading was mostly manual, traders could handle between five and eight orders at any one time. Advances in technology have meant that today, thousands of orders can be processed at once through the use of FIX connectivity, small order routers and algos. The workload has simply moved from the sell-side to the buy-side.
There are, however, benefits for the buy-side as the industry matures, due to the powerful technology now available, through increased regulation of the industry and changes in market infrastructure. These benefits include increased transparency and increased choice on how and where to execute. In addition far less people are actually required for trading today, as the traders role is more to do with overseeing the process, through technology.
Multi-asset trading
It is too early to have a full multi-asset trading desk because the operational processes are not aligned enough. Equity is one asset class; whether you’re trading a German small cap or a program trade of many hundreds of lines, you are trading one asset class and therefore the functionality and the market infrastructure you go through is the same.
However, fixed income, for example, is made up of multiple instruments that have very different structures and trading methodology; money market trading requires a very different skill set to the trading of rates, which again uses a different skill set to trading high yield credit. Currently, if you become a multi-asset trader, you would have a more a generalised skill-set. It is unlikely that you would be able to add the most value to your underlying client. So, I don’t think that the market infrastructure; technology or skill-set is sufficiently established for people to be able to trade seamlessly across asset classes.
“In addition far less people are actually required for trading today, as the traders role is more to do with overseeing the process, through technology.”
However, we are seeing implementation of electronic trading across the various different instruments within fixed income. Cash rates being the most advanced, which now utilise FIX connectivity.
There are key differences between equity and fixed income instruments, which is why I think it will take longer to establish multi-asset trading. There was some research carried out back in 2007 that looked at market liquidity which found that European equities had 9,000 listed instruments, which on average traded between 450 and 650 times a day. On the fixed income side, at that time there were 300,000 bonds and on average they traded one and a half times a day. A distribution curve of this would be hugely skewed to the side of cash rates. You might have some high-yield credit, some ABSs, some NBSs, that just won’t trade. They would be issued and then just held to maturity. There is therefore a clear difference between how these markets operate.
There are of course key differences between equity and fixed income which are nicely highlighted in TABB Group’s research from July 2012, ‘MiFID II and Fixed Income Price Transparency’. It highlights, that ‘one equity share is exactly the same as another (within its voting class), bonds issued by one entity are not necessarily all the same. Even bonds issued by the same entity can have very different features, such as issue and maturity dates, coupon rates, call and put features (if the bond can be redeemed early), and whether payment is secured by an individual or pool of assets’.
In addition, TABB studied ‘Xtrakter data, by examining a representative slice of European debt traded during Q4 2011 and Q1 2012. We examined five of the most frequently traded European companies: France Telecom SA, Belgacom SA, Deutsche Telekom AG, Koninklijke KPN NV and Vivendi SA. An equity investor would have two or three choices in the common stock of any one of these (because all of these companies had issued equity in more than one denomination). However, between the five firms, investors had the choice of a significantly greater number of fixed-income products.
- A total of 147 corporate bonds existed.
- One firm had issued six corporate bonds (Belagcom SA), while France Telecom SA had 55 bonds to choose from.
- The total number of fixed-income debt alternatives amounted to 207 products to choose from.
- The number of equity trades during the same data period dwarfed the debt transactions by 167 to 1.
- Deutsche Telekom executed almost 3,500 equity trades for each corporate bond trade.
- The size of the average debt transaction was 845 times larger than the average equity order.
- The average size of Belgacom’s debt trades was almost 2,600 times larger than their equity trades.
In essence it highlights that equities are one asset class, and trade relatively frequently, whereas fixed income have a higher number of bonds being issued but are traded far less frequently.
Since the 2007/08 financial crisis, there has been complete collapse in principal pricing and inventory levels are at an all-time low. This means that the market has shifted more to an agency-driven model. With regulatory issues prevalent, particularly MiFID II, pre-trade and post-trade transparency, there is some sense of the unknown with fixed income. We are in a rapidly changing environment and the direction of that change has yet to be fully determined.
Keeping the desk relevant
On the buy-side there has been a lot of focus on trade cost analysis to benchmark the buy-side trading function. In my view a broader metric is more appropriate to measure the added value, and therefore the relevance of the buy-side desk. For example through professional, experienced dealers; sophisticated technology and best practices.
Asset managers, hedge funds, asset owners that have a dealing function, have varying views of the value added of this function. Some houses put a huge emphasis on trading – it’s part of their DNA, and see trading as a crucial part of their overall investment process. There are other houses that see research as the main driver and execution as a minor detail, almost an administrative function.
Dealing Services provides a dealing platform for any buy-side house, to cater for these varying views. We offer the ability for fund managers to send their orders, to be traded, to specific geographic regions and within that, specific asset class desks.
One of the challenges for buy-side dealers is the maturing of the process of execution, through technology. This means that more trades have the ability to be executed automatically, with no intervention by a dealer and that the dealer needs to adapt his/her skill-set, so that their offering is still relevant.
“Some houses put a huge emphasis on trading – it’s part of their DNA, and see trading as a crucial part of their overall investment process. There are other houses that see research as the main driver and execution as a minor detail, almost an administrative function.”
This significant change in the buy-side dealing landscape is becoming of more and more interest to CEOs, CFOs, and COOs. They are questioning what value their buy-side desk can bring to their process, what cost is this to the business, and can it be justified.
This is what has changed the nature of the buy-side dealer’s relevancy. It’s about investing in technology and ensuring that the dealers have the required skill set. Technology will be leveraged to process the small liquid trades. Whereas the dealers will be required to have a skill set to enable them to pick up the illiquid, intellectually challenging, difficult trades where they can add the most value.
