The institutional investor community must adapt to new swap execution facilities and an increased push to electronify the fixed income market, both of which are set to dominate the agenda in 2014.
Will 2014 become a landmark year for the automation of fixed income trading?
The so-called electronification of fixed income trading is nothing new, but in recent years the pace of change and the volume of electronically-traded bonds has increased. Some industry insiders believe the rate of this change will push fixed income products to be completely traded on exchanges within a few years – with the caveat that this will include trades that originate from phone-based enquiries from the buy-side.
Already, the instruments that have shown the greatest propensity to exchange over electronic platforms are the very liquid products. A recent report from consultancy TABB Group showed that 71% of high-yield US corporate bonds under US$1 million were traded electronically. Also, a growing number of participants have indicated they would support new bond trading platforms.
Earlier this year, Liquidnet, a buy-side block-trading platform for equities, gave the strongest signal yet that it would look to address this demand with some sort of fixed income trading functionality. One can imagine if the platform were to start by offering buy-side to buy-side crossing in a small subset of the most liquid fixed income instruments, it would find immediate support from large asset managers – it’s core client base.
The buy-side will play a significant role in facilitating the continued shift towards electronic execution in fixed income. Its support of new platforms and innovation in this space though the allocation of its own fixed income liquidity will be, as ever, the make-or-break factor for new and existing electronic offerings.
How will the buy-side adapt to automated swaps trading on SEFs?
Swap execution facilities (SEFs) have dominated headlines throughout the year as asset managers and the swap dealers they have relied upon to execute OTC derivatives adjust to electronic execution and central clearing.
The key date will be the expected mid-February implementation of the Commodity Futures Trading Commission (CFTC) ‘made available to trade’ ruling, which will signal specifically which instruments will be traded on SEFs. Already, a large number of asset managers have signaled they have completed test trades and will be in a comfortable position with workflow through to settlement and reporting.
Dealing with pre-trade credit checks may pose a last-minute hurdle as there are reportedly still technology and workflow issues with how asset managers will ping their futures clearing merchants to ensure they have collateral to trade and then ping the SEF before a trade can be executed.
Will middle- and back-office automation for swaps and fixed income products pose a risk for asset managers moving towards electronic trading in these instruments?
With equities widely classed as highly electronic, even for large block trades that execute in sections through algos or on block-friendly trading platforms, the buy-side has the potential to harness its equities experience for fixed income and swaps automation. But, the focus so far on automating these products has focused on execution, while crucial middle- and back-office functionality has featured less. Asset managers moving too far ahead on front office-related advances will be forced to play catch-up for functions spanning the full lifecycle of the trade.
Already with fixed income, there is a disproportionately high level of failed trades, which are mostly due to issues encountered in the middle- and back –office.
The complex nature of derivatives trading will also render experience in equities helpful, but not so relevant when dealing in the minutiae of swaps trading, clearing, settlement and reporting for SEF-based execution.