Bond trading: Information trumps execution

By:
Peter Lee
Published on:

Inside the honeycomb: is this the future of bond trading? As bond market participants face up to the reality of diminished liquidity, low turnover and heightened risk of price gapping, the search for solutions is veering away from new trading protocols and exchange-like platforms towards providers of high quality pre-trade information. Do Algomi’s Honeycomb and MTS’s tie-up with B2SCAN point the way ahead?

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Bond market participants are fast realizing that the answer to the problem of diminished ability to turn over positions is not so much new trading protocols – because, aside from a few government benchmarks, bonds are inherently illiquid. Rather, it is essential for asset managers to develop a better way of identifying which counterparty to approach to take the other side of an order in the first place.

Pre-trade information is the key. Execution itself is a secondary consideration.

"The noise around market structure change is becoming much more concentrated now around quality of information and point-to-point connectivity," says Dominic Holland, director of credit e-commerce at Deutsche Bank. "The old model was about passing as much information as possible to as many people as possible in the hope of discovering the other side of the trade. But market participants now see the need to become much more focused."

Deutsche is far from the only sell-side firm encouraging buy-side solutions to the liquidity conundrum. "Ultimately, the winning model in all this will be the one that gets the buy-side’s inventory moving," says Niall Cameron, head of EMEA markets at HSBC. "Enticing that to happen just by offering to show more dealers’ axes has a limit. It's been estimated that the dealers collectively hold approximately 1% of the bond market now. What’s needed is something that further coaxes out the buy-side’s cares and interests and makes those big holders of the 99% of the inventory more likely to move some of it. This is now the cutting edge."

Algomi is right on that cutting edge. Set up in 2012 by three founders of the UBS Price Improvement Network (PIN), Algomi, as Euromoney reported in May 2014, casts itself as the anti e-trading alternative for bond dealers and investors.

Its first product, Synchronicity, was for dealer banks and comprised technology to capture all the stray data flowing across a dealing room – on previous filled and unfilled investor queries in certain bonds, on completed trades, on portfolio positions after a new issue. New enquiries and orders might then be properly collated and channeled to the right salespeople, and give them a better chance of matching up customers pinging in requests to the bank from anywhere in the world.

When Euromoney sits down with Algomi chief executive Stu Taylor, the firm is just two months into full launch of its second offering, Honeycomb, which this time is targeted squarely at the buy side.

You have to recognize that for clients wanting to do large size in today’s illiquid markets, even merely enquiring about a bond can move the market price against the investor
Stu Taylor

Honeycomb does something quite remarkable. It allows an investor to set up an encrypted listening station inside a banks’ bond dealing room – with the bank’s permission of course. Without the bank even knowing, the investor can interrogate that bank’s systems about certain bonds, as it seeks to identify the right bank to approach to get an order filled.

"We are an information network concentrating on illiquid, non-benchmark bonds in which investors want to do larger ticket sizes than typically flow across e-channels," says Taylor.

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Algomi chief executive
Stu Taylor

"You have to recognize that for clients wanting to do large size in today’s illiquid markets, even merely enquiring about a bond can move the market price against the investor. Investors used to check prices with five banks in the days when the banks all used to show off about their risk-taking capacity. But today those five banks, instead of taking the order down on their books, will immediately start contacting selected other clients to try and set up the opposite side of the trade, and so the information leakage is both widespread and immediate. That’s damaging in thin markets even for benchmark bonds and potentially very damaging for the overwhelming majority of infrequently traded securities. If it has a large trade to do, the client would be much better off taking it to just one bank and maybe splitting it between principal and agency. But the question becomes: which one bank?"

That’s the question Honeycomb seeks to answer.

Taylor runs Euromoney through a quick demo. The buy-side user of Honeycomb – it could be any large institutional asset manager – wants to buy $27.6 million of Intel bonds maturing in 2022. The Honeycomb system shows up a heat map for all the dealer banks that allow the asset manager to access their systems. It may show that BNP Paribas has traded these same Intel bonds five days ago. It may show that Credit Suisse has a current axe on the bonds to trade for its own account. But it shows that Deutsche Bank also has a current axe to trade on its own account, has traded the bonds in the past three days, has some portfolio knowledge of which accounts may hold the bonds, has recently traded in similar bonds, perhaps of the same issuer but a different maturity, has a new research call on the name and has a hot live investor query to deal right now.