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 back liquidity.
Regulatory Readiness
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.
The 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 trading volume.
The 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 embrace them?
Bill Gartland is senior director of evaluation services at Interactive Data.