The current macroeconomic backdrop has left many fixed income buy-side traders wanting when it comes to sourcing liquidity using the traditional methods. Increasingly fragmented liquidity paired with dwindling volatility and divergent rate hikes globally have discouraged the already shrinking number of traditional liquidity providers from offering up balance sheet, particularly in size. In this environment, those still willing to make prices are choosier with who they will trade with and are likely to charge a wider bid offer spread.
This departure from the traditional sell-side – Credit Suisse became the latest to exit in March – has paved the way for new liquidity shaping trends in fixed income. Non-traditional liquidity providers such as Flow Traders, Jane Street, Optiver, and Citadel Securities have made waves in fixed income and all-to-all platforms provided by the likes of MarketAxess, Tradeweb and Bloomberg have exacerbated this – offering buy-siders a chance to face off against firms they might not otherwise have been connected with.
The proliferation of exchange traded funds (ETFs) and flows in fixed income has also enabled a more consistent approach to pricing on the buy-side. All of these contributing factors have led the buy-side to become more proactive as opposed to reactive when it comes to finding executable pricing and minimising opportunity costs, driving them into the arms of alternative liquidity options while the sell-side are unable to swing the bat in size. Increasingly, the buy-side are becoming price makers as opposed to price takers. However, the key hinge to cementing this trend as mainstream is data access.
“There’s been an increase in the willingness and ability to leave latent liquidity in the marketplace to try to get things done in a slightly different way,” explains head of trading at Jupiter Asset Management, Mike Poole. “I don’t yet see an increase in confidence around the price at which larger size will clear. There’s still some reticence on the buy-side to leave larger orders to trade at a certain price because of the lack of transparency that persists but for smaller sized absolutely.”
Tools available
In light of this, venues and vendors have been quick to respond by innovating to accommodate this new buy-side demand for control over liquidity and pricing. As willingness to leave latent liquidity in smaller size in the marketplace has grown on the buy-side, anonymous platforms such as Liquidnet’s dark pool and UBS’ credit trading solution, UBS Bond Port, have come more to the fore.
Anonymous all-to-all platforms provided by MarketAxess, Tradeweb and Bloomberg – which allow both buy- and sell-side firms signed up to the platform to trade with one another, including buy-side to buy-side – have also grown in popularity in recent years. This has been exacerbated by canvassing from venues and the ongoing offboarding trend seen across the industry, as participants try to reduce costs by trimming down the number of counterparties they use.
One of their chief selling points is that they allow buy-side to buy-side ‘market making’, reducing costs as the liquidity provider doesn’t need to capture the spread as in traditional methods of trading because the platform acts as an intermediary to absorb risk. They also come bundled up with tools offered by venues such as artificial intelligence-based predictive composite pricing which combines consolidated data sources with valuable trading data harvested on their platforms to offer users a more accurate reflection of where instruments are pricing.
All-to-all platforms, however, allow for some degree of information leakage. Unless one restricts a request, your cares are advertised, albeit anonymously, to all users of a platform and there is a fee associated with expanding that network. Revealing cares in the market without any footprint is central to much of what the fixed income buy-side is trying to achieve – opportunity cost is the biggest challenge they face day-to-day, particularly in fixed income where instruments trade far less frequently.
“One way of getting around that [uploading cares without information leakage] – and it’s something that’s been attempted a number of times in the market – is auctions or certain times of the day where there might be a liquidity aggregation,” says Poole. “You put orders into a platform at certain time and maybe there’s an attempt to execute it at mid-price that could help you reduce opportunity cost.”
“On some of the platforms you can search by ticker and see what did not trade, which gives valuable colour. You can see that people have been looking for the offer in a certain credit and it hasn’t traded anything north of a million all day but people who have been looking for the bid have been able to sell in larger size. That suggests the bid is a bit deeper and if you’re trying to buy then perhaps what you need to do is try in smaller size. You can formulate a strategy without really leaking too much information.”
Aware of the desire for a more tailored approach to uploading cares, Bloomberg is set to introduce a new functionality to its all-to-all platform, Bloomberg Bridge, in the fourth quarter – allowing buy-side firms to post their indication of interest via axes anonymously.
“Bridge Axe will offer buy-side the opportunity to post axes anonymously to Bloomberg,” says Paul Kaplan, global head of credit, equities and TRS at Bloomberg. “If someone wants to engage on those axes, they will be able to go directly to that counterparty or they can choose to expand their inquiry to the full Bloomberg Bridge network.”
Data is king
Central to the success of all-to-all and similar anonymous platforms, is data. Data is essential to buy-side confidence in price making, allowing firms to build a clear picture as to how and why an instrument will price to give them best execution – something they are expected to be able to prove thanks to Mifid II requirements.
“If I go out and advertise that I’m the seller of a bond at 90 or 90.5, I need to be able to capture alternative data to prove that that was in fact the correct level for the bond,” explains Ninety One’s head of trading, Cathy Gibson.
Alongside the growing realm of all-to-all, new artificial intelligence-based tools have continued to launch aimed at giving traders a clearer picture of the market – ultimately giving them more confidence and autonomy over where things are pricing. Liquidity analysis tools such as Ediphy’s new Liquidity Checker that offers users real time notifications of shifting liquidity and solutions such as Wavelabs’ eLiSA credit trading system that includes predictive pricing solutions for bonds based off of TRACE data in the US, have come to market as of late. Data remains paramount for equipping the buy-side with the information they need to correctly and confidently price.
“What’s difficult for us as an active manager is knowing where larger size clears and that’s the lack of data that’s always been the issue in fixed income,” adds Poole. “There are opportunities out there to know where and how things are clearing, such as the dealer sweep and some post-trade tools, which come at a cost. Until we have more colour on that I think there will be still reticence to leave large orders without knowing where they might trade. The consolidated tape of the future is seeking to solve that. Without that consistent resetting of where risk can get priced and where investors are willing to put money to work, long only managers especially will remain reluctant to make those prices.”
The need for quality pre- and post-trade data has only been exacerbated by Mifid II and best execution requirements where firms – especially if when making prices – must prove they have serviced their clients to the best of their ability. Without reliable data, institutions lack the conviction to price make effectively. While firms are every day becoming more and more sophisticated using composite tools and advanced TCA, more work needs to be done. Markets that can naturally have less transparency like credit and the emerging markets will likely be even further behind the curve.
The success of all-to-all offerings hinges on data. They have had more success in the US thanks to consolidated public data sources and a subsequently much higher see rate for instruments that have meant the buy-side in the US have committed significant resources to pricing back. However, the lack of a similar consolidated data offering in Europe and the UK has slowed the progress of all-to-all, as those limited few with access to a valuable and clear picture of the market are more reluctant to leak that to others.
The consolidated tape for fixed income is one potential solution and has been confirmed by regulators on both sides of the channel. However, it has not yet had an implementation start date agreed upon in either the EU or the UK. Meanwhile, key aspects of it such as deferrals, flags and who the provider will be, are yet to be decided. The likelihood is we are still a way off and until prices move away from being indicative to being more commoditised, mass adoption of all-to-all is likely a way off too.
“We have to be careful also because if the transparency regime is causing damage by information leakage too soon in a cycle, it will affect banks’ appetite to take on risk positions if they don’t feel that they’re protected enough. There’s a trade-off to it as well,” says Gibson. “It’s catch-22. The high value add of me going out and price making is on stuff that doesn’t trade and where possibly there isn’t much transparency around it. Unfortunately, the situations where I would envisage being happy to go out [and price make] are also the ones where transparency on the market is probably not as high as other areas.”
Essential, and still lacking in the market, are clear indicators around liquidity type. The type of liquidity accessible in the market has massively changed in recent years – exacerbating the need for clearly defined flags in the consolidated tape of the future in order to understand why a transaction has happened alongside historical trade data.
“The buy-side would be potentially more willing to show their cares if they knew that their axes were being labelled and disseminated in a more granular and smarter fashion. If you start labelling types of liquidity that are out there it offers more confidence and clarity around how to engage with that,” says Poole.
“The onus is on us to ensure that we’ve got the right data feeds, the right opportunities to access the liquidity when the time is right and the price is right in a marketplace where we are frankly at the mercy of a number of participants who are far less price sensitive. That’s why you’ve got to be careful because once you reveal that you might be a buyer then the likelihood is there will be an algo out there able to buy ahead of you.”
A way off from market making
Buy-side shops can iceberg orders via external venues such as Bloomberg’s AllQ platform – which shows dealer-contributed prices in real time for bonds – via the UBS Bond Port solution. However, whether or not the market is able or willing to evolve to allow buy-side firms to quote directly onto said platforms remains to be seen.
“I’m not sure necessarily that the market would take that well,” says head of trading, fixed income EMEA, at Liquidnet, David Everson. “That’s not to say there aren’t places where buy-side can make their own pricing and stick a firm order out there for people to see.”
Due to a limited handful of offerings such as Liquidnet’s new issue trading platform, buy-side use of central limit order books in fixed income remains incredibly low. Contingent on liquidity, some quantitative and proprietary trading firms use them for the Treasury markets. However, the process of trying to get hit or lifted on bids and asks doesn’t match the majority of traditional long only firms’ business models.
While buy-side firms are not yet in the business of ‘market making’ as such, they are increasingly taking matters into their own hands when it comes to pricing using their desired methods. With new tools becoming available all the time, the buy-side are no longer limited by the traditional methods of making prices and sourcing liquidity, and they know it. As data access ramps up, this autonomy is only set to follow suit as the prospect of a widely adopted order book for more transparent fixed income instruments becomes a reality.
“It’s not beyond the realms of possibility to get to a point where there’s an on the run investment grade order book where the buy-side can leave orders up. It’s no different to leaving something on AllQ currently with UBS Bond Port or leaving something on Open Trading at a level,” says Poole.
“In the next 12 to 18 months, some of the more on the run credit space could be ripe for that sort of trading. Quasi order book, small size, executable, click to trade, the algos will get smarter quickly. The technology will allow for it and then it’ll be down to confidence in the data.”