| Buy side expect e-trading volume to rise |
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| Interest rate swaps and CDS under-represented in e-trading |
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| Depth of liquidity matters for the sell side |
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| Source: SIFMA |
THE WORLD’S SECURITIES exchanges, which are all trading on historically high P/E ratios, are eyeing fixed-income markets for growth opportunities. Inter-dealer brokers are creating new strategies including mergers and acquisitions, and the various data vendors/platforms are seeking to expand their product ranges. It has been several years since electronic trading was last in such a state of flux.
The emergence of LiquidityHub provides the clearest example of how the electronic trading landscape in various debt asset classes is set for a revolution. The LiquidityHub dealer consortium will finally drag European interest rate swaps trading into the electronic age.
But other mainstream sectors, such as US swaps, US treasuries and euro sovereign bonds, are lined up for an imminent makeover in the method of trading and delivery of product to end clients.
Furthermore, European sovereign debt managers appear, at last, to be accepting the liberalization of the electronic trading of their securities. This change will have significant implications for dealers, investors and the various trading platforms in business-to-client (B2C) and business-to-business (B2B) areas in the biggest area of the European cash fixed income markets.
An important backdrop is Europe’s new regulatory regime – the Markets in Financial Instruments Directive. Mifid has focused dealers on the future of trading securities; it will be increasingly electronic. Virtually the only simple way to conduct flow business and meet the directive’s requirements on best execution, for instance, is to trade electronically and capture mandatory information.
LiquidityHub’s arrival is a unique response from the leading banks to the problem of moving a relatively complex derivative product from voice to electronic mode in an optimal manner. This vehicle is not an inter-dealer platform; it will pool dealer liquidity prior to redistribution onto client-facing operators (Bloomberg and Reuters).
Robert MacLeod, CEO of LiquidityHub, says: "The strategic standpoint of LiquidityHub and the objective of the banks was centred around the interest rate swaps market, which seemed then, and still does, the next big opportunity for e-trading in fixed income. While there are a number of places that one can trade electronically in this particular product, no one has created a dominant platform and certainly not in the multi-dealer space."
Stark contrast
Expectations that deep pools of pan-European secondary market liquidity would emerge in all debt markets following the introduction of the euro were the norm back in 1999. But the vision has materialized only in bond futures derivatives trading, where for something like 10 years significant volumes have traded electronically. According to an authoritative survey (see charts) by the Securities Industry and Financial Markets Association published earlier this year, some 54% of sell-side bond futures trading volume is electronic. This is in stark contrast to electronic trading of interest rate swaps, where volumes are a paltry 12%, way below the average for other mainstream debt sectors too, according to Sifma.
The consortium that established a plan to create a pool of liquidity in European interest rate swap markets trumpeted its intentions in February 2006. Initially comprising 10 banks it has now expanded to 15: ABN Amro, Bank of America, Barclays Capital, BNP Paribas, Citi, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan, Lehman Brothers, Merrill Lynch, Morgan Stanley, Royal Bank of Scotland, Société Générale and UBS.
"The objective is for the dealers to get to their clients through a broad range of avenues that are convenient to the clients and efficient for the banks. We have contractual relationships with Bloomberg and Reuters to carry our product. We have almost completed the building of what we call the hub – which is our technology platform," says MacLeod.
The banks saw electronic trading in interest rate swaps as a conundrum. Although they acknowledge that they need to be able to react to their clients’ wishes and provide liquidity electronically, they also want that liquidity provision to be sustainable – in other words, profitable – over the long term. LiquidityHub was born out of the concept of a mechanism by which the dealers would be able to participate in the form of new electronic marketplaces but without requiring yet another screen that their customers would have to log into and support from an IT perspective.
"The banks wanted to change the model in order to pool their liquidity and distribute it through as many channels as possible and to as many clients as possible, rather than the current model run by the platforms. We wanted to make it much more transparent so a client could access liquidity electronically through whichever mechanism is best for them," explains Gavin Dixon, business development fixed-income trading at BNP Paribas.
According to Dixon this development will give the main platforms every opportunity to have a viable product. "If you look at the swaps market there is not really a viable platform. There is minimal volume on TradeWeb and Bloomberg in swaps – in a multi dealer environment."
It might have been an initiative from Bloomberg that gave dealers the impetus to create LiquidityHub. There have been previous attempts to drive interest rate swap trading electronic, including some from exchanges such as Liffe (as it was then known) and Eurex, but these failed, in part because the dealer community did not buy into the proposals. Bloomberg came up with the idea of creating Swapshouse in 2005. It would have been a trading platform where the dealers held equity stakes. But the emergence of LiquidityHub stymied the development of the Swapshouse scheme. It takes bank prices into a hub from which they are then exported to Bloomberg and Reuters where clients can access them.
LiquidityHub’s trading protocol is also different to other debt platforms, it is not request for quote (RfQ) but request for stream (RfS). Once a client selects three dealers it will receive a stream of prices for a period of time. This should reduce some of the issues caused by RfQ, where there can be problems caused by the static nature of the protocol. RfS might even boost the use of algorithmic trading methods, which are rarely used in fixed income. But that is another story. At present the leading banks do not envisage algo traders as a client constituent.