April 2007
Electronic trading: Members not so keen on letting hedge funds into EuroMTS
The supervisory board of MTS, the European bond trading platform is to receive recommendations from a committee, comprising mostly banks, on opening up the platform to third-party access during the middle of this month. Allowing hedge funds entry would dramatically change the number of players and might boost liquidity. However, few existing participants think the plan is a good idea.
Flat yield curves and becalmed bond markets have done EuroMTS few favours in terms of volumes in recent years. Although the platform remains the leading inter-dealer market for sovereign debt it has suffered from declining volumes. Activity fell 22% in 2005 on the previous year and 2006 was also disappointing – down 15% on 2005.
Hedge funds account for only 10% of investment in European sovereign debt, according to a poll of the top 20 EU bookrunners conducted by the BMA (now SIFMA) in September 2006. But the importance of hedge funds is magnified by the fact that they trade more frequently than other types of investors. Furthermore, they are the fastest-growing client category that trades electronically (see chart).
Sovereign debt market dealers suggest that it is mostly because of these declining volumes that the possibility of third-party access is being so actively considered by MTS. The idea was first voiced last autumn and at the EPDA conference in October MTS officials were very positive about the proposal.
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Hedge funds: the fastest growing customer group |
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Sell-side percentage of volume traded electronically by customer type |
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Source: EPDA |
But the European Primary Dealers Association argues that because of quoting requirements that eurozone sovereign debt managers impose (except in Germany) on dealers it is not fair to involve third parties that are not operating under the same conditions.
"We generally think it’s a bad thing – we are against the introduction of hedge fund to the platform," says one dealer.
He argues that MTS is in a difficult situation. It wants an exchange model, which would facilitate greater volumes. And although BondVision – the group’s existing multi-dealer to customer platform – has enjoyed growth, customers can get better liquidity on TradeWeb and Bloomberg for government debt.
Primary dealers fear that algorithmic trading strategies would enable hedge funds to pick them off. "The way hedge funds are going they are looking to use algos – it’s almost an IT competition and they want as much liquidity as they can get," says one banker. The ironic aspect of this development is that it was an algorithmic trading strategy that got Citigroup into trouble on the platform in the summer of 2004.
The European sovereigns are said to be unenthusiastic about involving hedge funds. They see the MTS programme as offering transparency where they had none before. But it may be that their rules are out of date. The lack of liquidity that peripheral sovereign debt lacked before way EMU days is far removed from the current market where large amounts of money are chasing any relative value. The European Commission is now looking at the sovereign debt market with an eye to possible restrictive practices by the debt managers, so perhaps this proposal might be the cover needed to trigger real change in the sovereign debt market’s micro structure.