Hayley McDowell: As one of the original fixed income trading platforms, how has Tradeweb managed its expansion across asset classes and market participants?
Lee Olesky: If you look back over the last 20 years and through Tradeweb’s history, our growth is built upon a couple of different fronts. One is the horizontal growth, which is our network and the addition of clients across various regions, starting with US, then Europe and moving into Asia. Then across our products, or asset classes, and we now offer more than 20 products which we trade. We started in US treasuries and then we added mortgages, European government bonds, derivatives, etc. That’s the horizontal growth of a network of investors and liquidity providers and then across the geography and different asset classes.
The second angle is our technology growth. We now have around 275 people in our technology team, and over the last 15 to 20 years, the team has built more complex technology that allows for all of the things we do at Tradeweb. Essentially, what we are doing is streamlining interaction between counterparties. We are building tools that infuse pre-trade analysis into execution, and then once the trades occur, leverages the data in new ways and in post-trade processing. It’s all about automating the workflow of what used to be - and interestingly enough is still a big component in fixed income - a phone based business. We took a market that was entirely phone based and we moved into a digital environment with the technology that we offer.
Finally, we have managed our expansion through our focus and understanding of market structure. We have tried to ensure we are adopting rules under which the markets can function effectively and efficiently. There needs to be a real in-depth understanding of how these products trade so that when we present them to the market, we make sure we are offering appropriate rules of engagement. This is fundamental for any marketplace to function and has allowed us to drive scale in delivering efficiencies to fixed income and derivatives trading.
HM: What have been the key factors or challenges influencing change and shifts in your strategy to make markets more electronic?
LO: In terms of accelerators, it’s hard not to rank regulation top of the list. Regulation has been a huge accelerator for the derivatives market in the US because of Dodd-Frank and the swap execution facilities (SEFs) rules. That’s a market that was a few percentage points electronic, but has moved to more than 50% electronic, chiefly because of regulation. Regulation has required people to trade on new regulated entities - SEFs - and once that happened, the market moved electronically very quickly. It has also been an accelerator for market participants in the broader sense because of the constraints on capital and the rules around how broker-dealers run their business, which requires a different approach to operation efficiencies. Regulation may look to have paused here in the US, but we have a major push in Europe with MiFID II beginning in January 2018, which will continue to drive an awful lot of change and opportunity in the markets over there.
Additionally, technology innovation has been a huge influence in our strategy. When we started this business, one of the biggest things we had to decide was whether to use the Internet or not. In 1996, it was a big decision because nobody back then used the Internet to trade securities in an open fashion or at the size we had set out to do. When we opened up in 1998, we were really the first firm to establish an organisation that would be trading billions through the Internet.
From there until today, the amount of innovation in technology has been exponential. Whether it’s instantaneous price generation, algorithms or matching on our systems, all of this content has been transformed into electronic data. We believe technology - alongside regulation and operational efficiency components - will continue to be a huge accelerator for us.
The challenge has been behavioural change, where for many years it has been difficult to persuade people to trade electronically as opposed to picking up the phone. I remember the first five or ten years of our business, our competitor was the phone. Although people are more sophisticated in terms of technology usage and their willingness to accept change, phone trading remains a significant competitor because so many asset classes remain relationship-based businesses.
The cost associated with that change is probably one of our bigger challenges, because when we do something in the marketplace, it’s not just the cost of innovating and developing new technology at Tradeweb, it has to be accepted by market participants. That often means all of the firms that connect with us must be able to adapt their technology to deploy with our technology. There’s a collective cost and challenge.
HM: In today’s trading environment, what are the key characteristics that are affecting electronic trading?
LO: Market volatility and the potential for even higher volatility in markets is clearly what we are seeing today. That is going to affect all trading, but certainly electronic trading. The shift from a low interest-rate environment to one that has a likelihood of becoming a rising interest rate environment will be trend we all have to pay attention to.
I also think the business model changes with new types of enterprises in this space that didn’t exist five or so years ago. These are new types of market participants now playing a role. Another key characteristic is the new profile of FinTech - a new term penned in the last few years. It’s an area drawing a lot of capital that will drive new business ideas and ultimately consolidation.
HM: Considering these issues, we haven’t seen disruption of electronic market structure in fixed income and derivatives. Has electronic trading reached a ceiling?
LO: The right way to answer that is to look at what is going on in fixed income. A statistic from Greenwich Associates compared how much U.S. fixed income market volume is traded electronically in 2015 and 2016. It showed that electronic trading has grown in the last year from 40% in 2015 to 45% in 2016. I would say that figure will increase even further in the coming years. It’s hard to predict the shape of the curve, but without a doubt the number will increase significantly in terms of how much of the market is traded electronically.
It’s only 45% at the moment and it could easily increase another 20% - 40% over time. If you delve into this for different asset classes, the credit market - which we now have a huge focus on at Tradeweb - has seen e-trading in high yield roughly double over the last year to 8% electronically traded. Those markets will move significantly more electronic and I think there is no question there will be more business done electronically in the future because of the more efficient workflow.
HM: The concept of data science, or big data, has been around for some time, why is this relevant to fixed income and electronic trading now?
LO: Big data is another area of tremendous growth and we are in the early days of the financial services industry figuring this all out. In the retail space for example, we have seen more advances with this than in finance. As the market moves more electronic - and data and execution become more closely tied together - we will be capturing the information digitally. There is a wealth of growing information in terms of prices, inventories and activities of market participants.
People are spending a lot of time in capital markets trying to distill that with algorithms and artificial intelligence to maximise its value. For us at Tradeweb, we are leveraging data science already with integrated distribution of axes, streaming prices, sizes and inventories. This creates a lot of cross-market information between all of the fixed income markets.
There’s so much happening there and it will be an area that will ultimately lead to a better way of searching for the other side of the trade. Historically there has been a focus on the dealer to customer market in fixed income, but in the future for certain instruments there will be tools that will allow you to search across the entire marketplace to execute a trade by leveraging all of this data.
HM: How will this impact Tradeweb and market participants in terms of their electronic trading?
LO: Intelligent Execution will drive the next wave of e-trading, connecting data science from the marketplace with a flexible market structure that allows you to execute properly. It will also provide a better sense of best execution, which is another factor that has led to people trading electronically. Meanwhile, the tools that surround electronic trading will continue to grow. The demand for electronic trading will be stronger because the value you gain from it will be greater. So how to evolve best execution in this space is critical. Tradeweb has a number of tools that are already deployed under this umbrella of using data science or big data to help with Intelligent Execution.
We have functionality that helps inform and automate the process of selecting who you would go to for a trade, and tools that help aggregate buyers and sellers regardless of where they might be coming from. There’s an awful lot of innovation that will impact Tradeweb in the coming months and years.
We are at a point now in the market and we’ve had a strong November where we hit a record of $7.9 trillion in volume. Now, across all of our businesses we are facilitating over $400 billion in trading a day. It’s a moment in time where there has been a lot of positive momentum, kicked into hyper drive by the US election, and I expect next year will be very active for fixed income markets.