Too much information

A number of new regulations will radically alter the way many types of assets are traded, shaking up long-established protocols particularly in the fixed income and OTC derivatives markets.

In short, market structures are beginning to converge, which may lead to a reappraisal of the skillset required by buy-side traders, specifically more autonomy, through a further increase in self-directed trading and greater choice in deciding the most appropriate route for gaining a particular exposure.

But while this might seem like a logical evolution in theory, achieving this in practice may not be as straight forward.

In Europe, the regulatory vehicles that drive these changes will be MiFID – which will impose on equity-like and fixed income instruments pre- and post-trade transparency and encourage more exchange trading and EMIR, which will standardise many OTC derivatives, including the US$700 trillion swap market, to become suitable for exchange trading and central clearing.

Some aspects of trading were already converging before the financial crisis strengthened regulatory resolve in the quest against opaque markets. For instance, pre-MiFID, buy-side traders only needed to consider one venue of execution for stocks. But liquidity fragmentation has moved equities trading closer to fixed income in terms of having to hunt around for the best price, smart order routers notwithstanding.

And as fixed income and OTC derivatives markets become more automated, we are heading to a place where the markets for different asset classes are slowly becoming more homogenous.

Although knowledge of market structure is already key to understanding how to execute in the equity markets, a broader appreciation of similar factors across different asset classes could become absolutely necessary.

Using information on aspects such as fragmented liquidity, consolidated pre-trade price feeds and the costs associated with clearing, for example, a buy-side trader may decide that an option may be the best way to retain, or even add, alpha, rather than an credit instrument.

This means even greater cooperation between fund managers and the trading desk in trying to determine the best type of instrument to gain a particular exposure.

In some buy-side firms, traders are often left to the find the most appropriate corporate bond from the wide variety of issues on offer based on PM guidelines. To widen this autonomy on a cross-asset basis would be a further step from the days when PMs told dealers exactly how, and with whom, to execute.  

But a shift of this magnitude may not evolve in synch with market structure changes. Whereas a hedge fund may be less constrained and able to swing seamlessly from one asset class to another, this may not be the case for many traditional long-only asset manager that may be restricted in the types of investments available, either through mandates or portfolio managers that are concentrated in one asset class.

There is also the question of the amount of knowledge a buy-side trader should be expected to retain. The speed of change in any one asset class is hard enough for the buy-side trader to manage already, so a requirement to preserve specialist knowledge in multiple asset classes may just be one step too far. Buy-side traders have been known to grumble about the effects of sell-side integration of sales traders into multi-asset teams and may not be keen to try the trick themselves.