Ever since the financial crisis, the accepted wisdom has been that a handful of big trading firms will dominate trading in fixed income, and generate an oligopolistic pricing benefit from providing the key intermediary role in the bond markets.
As smaller, more weakly capitalized banks withdrew, they argued, there would be a chance for bigger, stronger competitors – such as the US banks that either never got into problems in the financial crisis or that have since cleaned up their balance sheets – to profit from the old bond trading structure, as they did in 2009 when half the banks were paralyzed and bid-offer spreads widened meatily for those still open for business.
Such benefits show little sign of appearing. In recent weeks, Barclays, Citi, Credit Suisse and Deutsche Bank have been among firms – all of them ranked among the top tier of the fixed-income and currency markets – to warn that their FIC trading revenues were suffering in the third quarter.
That could be one reason why a number of banks – among them HSBC, Barclays and Deutsche Bank, Euromoney understands – are actively looking to develop new ways to trade fixed income products.
Zar Amrolia, who drove Deutsche Bank to the top of the Euromoney FX survey over the past decade, is now co-head of FIC, a newly combined fixed-income and currency-trading division of the bank.
He says: “We never had the biggest balance sheet or headcount in FX and our journey to dominate that business followed the migration of foreign exchange from voice to electronic.
“Fixed income is going to travel that same route, this time driven by regulators who want more transparent, data recordable and cleared markets.
“We have put significant staffing into a new electronic trading group who are looking at transitioning our workflows, liquidity provision and risk management, and gearing the whole DNA of the fixed-income trading business to an electronic future.”
Deutsche has played a lead role in mobilizing other dealers’ support for moving to a more centralized liquidity model.
Amrolia says: “New business models will emerge for how we price and manage risk across markets like government bonds, futures, credit, swaps and even FX that for now are run off separate desks, but that all have at times high correlations.”
Part of the new thinking seems to centre on quickly transferring risk capacity from one asset class to another during peaks in correlation between them so as to bolster the bank’s ability to take on customer flow.
Could the bank be ready to lead the way to new trading protocols in fixed income: towards a centralized liquidity pool with an order book and the attributes of a stock exchange for bonds?
Dominic Holland, global head of e-credit sales at Deutsche, says: “The challenge in developing new protocols is that investors want anonymity to protect them against information leakage as to their intentions before posting trades in an open market.
“Dealers still have shorter-term horizons than investors and the balance sheet that is key to liquidity. But dealers see the information flow in credit as the quid pro quo for taking on risk.
“Credit is all about knowing who is positioned in what and what triggers might prompt shifts in positions. And it is client relationships that release capital to provide liquidity.”
Holland, who worked at MarketAxess when it launched in Europe 10 years ago, has been talking to other dealers to develop protocols for a new multi-dealer platform that will ultimately be managed and operated by a third-party vendor, possibly a new entrant into electronic bond trading.
The outline is that this will be built on a matching engine, with buy-side clients going through sponsoring banks to post indications of interest to trade in certain securities on an anonymous basis.
Holland says: “If a participant enters an indication of interest into the matching engine, that remains hidden until another participant comes in with an interest to take the other side, at which point both participants are notified and can negotiate as to price and size.
“If the first indication is Deutsche with a client order and the match is from another bank representing a different asset manager, then even post trade both asset managers won’t know they have crossed with each other. The banks will retain information from their clients that they can in turn use as valuable feedback in the primary markets.”
Holland began conversations with buy-side clients 18 months ago to assess their requirements and has spent this year talking to other dealers on the project, which carries the internal working title Oasis. The next step is to hand the project to a vendor.
“This is not going to be a Deutsche Bank platform,” says Holland. “It must be multi-dealer and we are in very advanced conversations about this with other dealers.
“They don’t see this as cannibalizing their existing offerings because right now, in a credit market with maybe 50,000 ISINs or Cusips, all the trading is concentrated in fewer than 1,000 issues. This project will help get trading started again in those other securities.”
He adds: “It needs the largest capital providers working with their buy-side clients on a relationship basis and that is what we’re doing that is different from most of the other new proposals.
“A core of large dealers will be very supportive and also many of the second-tier banks see it as a less capital intensive way of maintaining their buy-side client relationships.”