A recent TABB Group report, ‘US Fixed
Income Market: Industry Trends & Drivers 2014,’ looks at the
principal-based risk model used by fixed income and how it has deteriorated
underneath the vastly growing size of the market it supports. The report cites
a 70% growth of the US treasury market since 2008, noting that the US corporate
bond market is now 45% larger than before.
As the fixed income market experiences a
shift from an over the counter industry to a more electronic market, it needs
to get creative in order to boost liquidity and create more pre- and post-trade
transparency. This article will provide an overview of changes in the
fixed-income market in the context of regulatory reform and electronification
and proposes how to find transparency in this changing market to help bring
In the US, the Securities and Exchange
Commission (SEC) is looking to increase transparency into trades in the
relatively opaque markets for corporate and municipal bonds. There is
especially a need to create a more transparent bond market capable of managing
a potential shift in balance sheets to facilitate large sell orders that may
occur in response to rising interest rates. The SEC has also called for stress
tests of mutual funds to assess their resiliency in such conditions.
European regulators are seeking to bring
their credit markets to a level at least comparable to the US, which they hope
will inject more liquidity and encourage more trading and efficiency. The
biggest driver for increased bond market transparency may come from new
reporting mandates under the Markets in Financial Instruments Directive (MiFID)
II. Additionally, the Financial Conduct Authority (FCA) commented in March that
low liquidity in corporate bond markets could create volatility in times of
stress, requiring more careful monitoring and more real-time data.
Search for Liquidity and Continuous Pricing Data
As the fixed income market continues to
become more automated, at least partially in response to address the
regulators’ call for transparency, evaluated price information that is updated
continuously throughout the day, based on multiple inputs, can become a
reference point to help create a liquid, vibrant market.
The availability of such a reference point
paves the way for more sophisticated pre-trade analysis, best execution
compliance analysis and the development of transaction cost analysis (TCA) in
fixed income. Market participants need pricing data that will give them the
confidence to trade and so help boost liquidity, while managing risk. Traders
need to assimilate large volumes of information and data throughout the day in
order to effectively execute decisions.
Being able to analyse that information
continuously throughout the trading day can positively impact liquidity.
A continuous stream of fixed income prices
can help provide consensus and clarity around where value lies in times of
market upheaval and can promote the growth of electronic trading activity,
potentially adding the capacity needed to manage the expected increase in
Road to Restoring Liquidity
As the fixed income market adapts to
changes in regulation and liquidity, the availability of high quality
continuous evaluated pricing will be of increasing importance, whether it is
for best execution, or pre-trade and post-trade analyses.
The fixed income market is not a ‘one size
fits all’ market. A source of independent continuous evaluated prices can
provide consensus and clarity around where value lies, provide a reference
point that supports performance measurement across a range of functions and
pre- and post-trade analytics. The solutions are out there – will the industry
Bill Gartland is senior director of evaluation
services at Interactive Data.