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Joe Feerick, Head of Product Management, MarketAxess

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AFME panellists predict ‘survival of the fittest’ in electronic trading platforms

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Various voices from both buy side and sell side institutions debated the efficacy of e-trading and what the future implications of traditional Request For Quote (RFQ) inquiries might be at a recent industry roundtable.

The roundtable was hosted by Joe Feerick (pictured), Head of Product Management at MarketAxess, and Erik Tham, Head of Fixed Income Buy Side Algorithmic Trading at UBS Wealth Management, at the Association for Financial Markets in Europe’s 7th Annual European Market Liquidity Conference on Wednesday 8th February.

Regulatory developments under MIFID II and EMIR (European Market Infrastructure Regulation) will require the trading of derivatives to move away from an OTC environment to e-trading platforms and exchanges where pre- and post-trade prices are fully transparent.

This could potentially play into the hands of firms like MarketAxess, a leading global client to multi-dealer electronic trading platform, which has particular expertise in the trading of corporate bonds and CDS. Last year alone it traded USD500billion across 80 different dealers.

Whether buy side institutions are ready to full embrace this methodology, however, remains to be seen.

Certainly, Feerick is not getting carried away. He said that while he doesn’t believe the RFQ business is dead, “changes are taking place in the industry”.

The old fashioned days of doing everything OTC by telephone clearly do not represent the future of order execution. Given that Tham and his team execute client orders for all UBS wealth management clients, as well as handling part of the flow from corporate and institutional investors from UBS Asset Management, he’s able to get a good overview of trading volumes.

“The vast majority of flow goes to multi-dealer platforms: only around 5 per cent of best execution order flow is executed on exchanges. We hardly see orders of anything larger than EUR100,000 to EUR200,000 on exchange so volume-wise it’s very low,” said Tham.

Liquid assets such as investment grade bonds can be efficiently traded electronically via multi-dealers, whereas more illiquid asset classes still need to depend on multiple (or single) dealers and/or RFQ. Using a mixture of the two is the likely scenario, at least over the near term.

“Illiquid asset classes profit from an inquiry process – when an electronic order comes in we have multi-dealer prices plus those from exchanges and MTFs and we must then decide what to do. The dealers we choose are then asked directly about price via electronic RFQ – the goal is to always get the best possible price for our clients,” explained Tham.

Liquidity is an important consideration when institutions block trade. Depending on what instruments are being traded, convincing compliance officers that there enough counterparties in the market is a challenge and, crucially, transparency may not necessarily be welcome in such situations – after all, no investor wants to broadcast in broad daylight that it’s looking to sell USD300million of corporate bonds for example.

In the equities markets, block traders are able to get around the issue of price sensitivity by using off-exchange platforms (dark pools) such as those provided by the likes of Liquidnet and Deutsche Bank Automated Trading System (DBATS) – indeed, Deutsche also offers its Autobahn (e-platform) clients a dark pool liquidity matching algorithm called SuperX Plus.

The question is, as fixed income derivatives become more transparent, will they too be able to take advantage of apposite platforms? They may have to if they’re to convince buy side institutions. As one representative from Fidelity commented: “Flagging up large tickets on e-trading platforms will be disadvantageous and keep e-trading as a small ticket game in my opinion.”

Tham agreed with this and added: “Size of ticket does matter. There just aren’t enough counterparties around that are capable of handling very big tickets so best execution is not that easy. It needs to be done in a high quality, highly efficient way – e-trading on block trading facilities could be a way of getting around the block trade issue.”

The big ticket barrier for e-trading is gradually increasing Tham told Hedgeweek, pointing out that it is already much higher for interest rates than credit. “I ‘currently’ don’t see a platform that would be able to do all sizes in all products electronically,” said Tham, although he expects the e-ratio percentage to slowly rise.

Feerick noted that over the last few years the average trade size on the MarketAxess platform has increased from USD500,000 to over USD1million today. “Since e-trading today still represents a minority of overall credit trading by volume, we believe there is a lot of potential for growth in e-trading within our core trade size bracket,” said Feerick, who added: “We’ve been conducting extensive research both in the US and in Europe to quantify the transaction cost savings available to investors through electronic execution and have found consistent, quantifiable savings in every maturity and size bucket.”

Lack of counterparties remains an issue, and one that could give compliance officers a headache, but one of the great benefits of e-trading platforms and the multi-dealer model is, said Feerick, the fact that they “provide better pre-trade, at-trade and post-trade transparency, which should hopefully reassure those in compliance”.

As for client-to-client platforms, matching prices in such an environment is not easy to do. Agreeing to a specific number of focused products could be one solution to the problem. However, what also needs to happen is for the number of such platforms to be reduced. There are too many, and as one industry representative said, none of them are actually succeeding in capitalising on the situation – they are, in effect, simply cannibalising one another. This has the added unfortunate consequence of drying up liquidity.

“We are seeing a natural ‘survival of the fittest’ evolution. There are a number of healthy platforms out there that can co-exist for some time. Personally, c2c platforms that will be able to survive long-term will be those that can pool liquidity by specialising in a small enough universe of products; offer some sort of ‘killer feature’ that no-one else can offer, or are simply the fastest in attracting critical client mass,” Tham told Hedgeweek.

Feerick noted that dealers are happy to provide firm pricing on a certain number of products, and that buy side institutions, in turn, are happy to receive pricing from multi dealers. But in Tham’s opinion, it’s all about quality not quantity.
 

“For retail flow I’d rather have five dealers I trust on price than have a choice of 30 dealers with potentially unreliable prices. We re-rank dealers on a continual basis,” said Tham.

For buy side institutions, deciding when to go down the multi-dealer RFQ path and when not to is a balancing act. It boils down to assessing which tickets are the most important and therefore worthy of spending more time on to get the best price through dealer inquiry.

So how might the buy side perception and use of e-trading change over the next few years?

According to Feerick, total global volumes on MarketAxess increased over 30 per cent in 2011 compared to 2010. “We believe that current market dislocation, alongside global regulations, is having a lasting impact on fixed income market structure. We think these trends have put greater pressure on dealers’ ability to manage their risk and as a result investors are seeking liquidity from alternative sources through electronic trading.”

In Tham’s opinion, electronic multi-dealer RFQ will likely be the most widely used model for the next few years but he qualified this by adding: “It will, however, continue to be complimented by order-based models/exchanges/client-to-client platforms for small retail tickets and manual RFQ for very large tickets.”

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