Fixed income trading is moving inexorably towards an electronic market structure but the pace of change will vary across individual markets, according to a new study by consulting firm Celent.
The report, ‘The future of electronic fixed income trading-cash and derivatives’, says the fixed income market is evolving to meet the new needs of the markets participants and also regulatory compliance.
Regulatory efforts like Basel III, the Volcker rule, Dodd-Frank and MiFID II are taking its toll on the business models of the fixed income trading value chain, forcing capital optimisation and mandating certain clearing models.
“The net result of these regulatory initiatives will severely impact dealer models, putting pressure on revenues and thus liquidity in secondary markets,” says Joseph De Chazournes, senior analyst, Celent, and co-author of the report.
Most fixed income dealers have been spending the last few years responding to the financial crisis and adapting their business models to the changing market structure.
The historically dealer-led fixed income market is establishing greater transparency and improved execution processes, with firms investing to support innovation.
From a trading model standpoint, most effort is being made on concentrating liquidity with a minimum of capital and operational overhead. To overhaul the common buy-side practice of calling up brokers to discover the indicative price of a particular instrument, new models of price discovery are being developed. A particular focus has been given to innovation around gathering data and building proprietary models to determine a view on price, according to the report.
While the FX and equities market saw significant transition towards electronic platforms years ago, fixed income is only now moving towards it. Celent says that the trading technology innovation will focus on providing the building blocks of creating a more electronic market structure, with an emphasis on connectivity, smart order routing and algorithms. The report says that a more electronic market structure will drive demand for advanced technology available in trading other asset classes, including in-memory, high computational processing databases, advanced order management and execution management systems, algorithmic trading platforms, smart order routing, and even complex event processing engines.
The report further says the US corporate bond market will see a gradual migration to electronic, continuous order books for liquid issues and other more episodic but selective liquidity mechanisms which seek to concentrate liquidity for less liquid issues. In European cash, the report predicts further selective liquidity provisioning by dealers, while in European derivatives, it anticipates a similar type of standardisation of the swaps market after European market infrastructure regulation takes shape.