LEVERAGING HISTORICAL KNOW-HOW.

The e-trading of bonds in Italy has more than a 10 year history, but is quite new to the rest of Europe. Best Execution speaks to Luigi Campa, head of business strategy and development at EuroTLX, a leading European MTF for the e-trading of fixed income securities, to see what lessons can be learnt in light of the upcoming MiFID Review?

Blackrock’s Aladdin Trading Networks and Goldman Sach’s GSessions are only two of the latest trading venues that are incoming in the growing space of bond electronic trading. Since MiFID II will extend also to non-equity financial instruments requirements of liquidity and transparency, the fixed income world has started to reshape.

There is, however, one country in Europe where already the effects of MiFID’s first release in 2007 translated into an increase of competition amongst all kinds of bond trading venues (regulated exchanges, multilateral trading facilities, systematic internalisers). “Best Execution rules did not affect that much the Italian equity space, but they surely did for fixed income asset classes”, says Luigi Campa, head of business strategy and development at EuroTLX. “Of course, there are historical reasons behind Italy being so evolved in the e-trading of bonds, the main one represented by the strong public debt”.

In fact, when the first stock exchange was set up by the Chamber of Commerce of Milan in 1808, this was done not for permitting the industry to have access to a different financing channel, but for ensuring a secondary market to public debt issues, so that until 1863 only government bonds were tradable. “It is during these years that the roots of our public debt can be traced back: when Italy was reunited in 1861, the decision to recognize all government bonds of those states that came together in the Italian Kingdom was taken in order to assure foreign investors about the credibility of the newborn state”, explains Campa. “Since then, the country has always relied upon borrowing, with public debt multiplying by 1,885 times within one century”.

Thus, Italian investors have historically been used to handling with debt securities, and not only with the ones issued by the government: the whole banking system relies on issuing fixed income instruments as a main funding mean. “Italian banks have the highest bonds / total collection ratio in Europe, around 40%, and these bonds are mainly sold to private investors, representing 32% of their total financial assets”, says Campa.

The result of this is a highly competitive fixed income scenario: when MiFID came into force in 2007, Italy’s decision to extend pre- and post-trade transparency requirements to bond securities came not as a surprise. At that time, there were already two regulated exchanges, four MTFs, 330 alternative trading systems (which shrank to 18 systematic internalisers right after November 1, with the rest declaring to be non systematic) and four different Smart Order Routers awarding those venues with the best conditions.

“The Italian retail-size market is very similar to the equity model”, says Campa. “Trades on venues such as EuroTLX all run on a central limit order book, with full pre-trade transparency on a five-level depth, with price and time priority, anonymous and continuous, and with complete post-trade transparency”, Luigi Campa says. “Of course, in a world made up by hundreds of thousands of bonds, most instruments are structurally illiquid and thus are not suitable to be traded on an exchange, but on a subset of fixed income securities, such as govies, supranational, corporate and banking bonds, it is possible to have a very liquid market.”

The efficiency of the whole system depends also from how the post-trading works. “This is entirely straight-through processing, with settlement instructions automatically sent in real time to the CSD, ICSDs or CCPs, and with a daily reconciliation report provided to each market member.”

The CCP feature, in particular, is being more and more appreciated by market participants, since it guarantees also anonymity in trading and lowers the tied-up capital required by regulators. “With the Capital Requirement Directive (CRD IV) and Basel III imposing capital constraints to European banks, holding inventories of corporate bonds on their books will become extremely expensive: the development of electronic order books enables these bond stocks to move more freely from investor to investor, without banks to have to act as risk absorbers. Flow and electronic bond-trading business are clearly the future.”

Campa expands, concerning the highly debated issue of transparency versus liquidity, “what we at EuroTLX have learnt in more than ten years of running fixed income e-trading venues is that an increase in transparency actually increases trades number and volumes”. Besides, even the US can be taken as an example, with most academic papers arguing that liquidity was not hindered by TRACE, the corporate bond market post-trade reporting system that was introduced in 2002.

“The electronification of cash fixed income in Europe has, however, still a long way to go: if about 60% of government bonds are traded electronically in the dealer-to-client market, on non-govies this percentage goes down to 20%”, says Campa. “And there is lot that has to be done on the entire value chain. For example, interoperability for all financial instruments on the CCP side, and a consolidated tape on the post-trading side. But we are quite optimistic, and by leveraging on the experience gained on our home market we want to play an important role in the current reshaping of the European fixed income scenario”.