On October 17, Bank of New York Mellon, the world’s largest custodian bank, and HSBC announced the latest initiative to bolster liquidity in the bond markets in collaboration with Algomi, the innovative distributor of pre-trade data.
While there have been signs of improvement in fixed income liquidity since all-to-all trading took off a couple of years ago, with asset managers at times now making prices to each other on platforms such as MarketAxess, dealers continue to report a bifurcated market. In a small number of bonds, executing large-size trades without moving the price is still possible at a reasonable spread.
In the overwhelming majority, however, especially in the credit market, liquidity has all but disappeared. Investors taking on positions to capture spread in the corporate bond market must buy and hold rather than seek to trade for relative value, beyond a week or two after new issue.
And as rates now start to rise that illiquidity may have as yet unseen and damaging impacts on the cost of funding for businesses.
While the volume of debt outstanding has almost doubled since the eve of the great financial crisis ten years ago, turnover has shrunk. In a recent study by the UK Financial Conduct Authority, a leading fixed-income trading house reported that the number of corporate bond trades that actually result from orders and request for quotes has declined from around 65% before the financial crisis to between 20% and 25% in 2017.
The new proposal from BNY Mellon and HSBC is that the custody clients of the two banks will in future be able to make their bond holdings in custody available on a non-disclosed basis through a system powered by Algomi’s Honeycomb network, and delivered through Algomi ALFA.
Counterparties on the Algomi network will be able to query those custody bond holdings. The system will alert the beneficial owners and enable them to instruct their dealers to trade on their behalf while protecting clients’ identity. This could be done directly through BNY Mellon or HSBC affiliated broker dealer’s trading desks.
There is no golden source of data in the fixed income markets on who owns what, no central exchange-like marketplace and no registry of bond owners. Algomi focuses on private data that market participants do not want to broadcast but are increasingly willing to share selectively so as to improve the chances of finding the opposite and matching side of a trade. It has made significant advances in enabling more targeted distribution of pre-trade indications of interest between bond dealers and asset managers.
Algomi first developed Synchronicity, a tool allowing bond dealers to capture internally the vast amounts of stray data on dealings in particular bonds, in 2012. In 2015 it launched Honeycomb, a revolutionary system that allows dealers to permit select buy-side counterparts to be informed of queries on specific bonds coming into the dealers’ networks.
In March this year, Algomi announced a joint venture with Euronext to develop an alternative trading system, building more links between bond traders. In May it acquired fund manager Alliance Bernstein’s ALFA (Automated Liquidity Filtering & Analytics) system, an in-house liquidity tool for fund managers that aggregates information on activity and trade intent from multiple e-trading venues in an effort to give the buy-side a real-time view of the entire bond market.
Engaging now with the custody banks is a logical next step. BNY Mellon alone has assets under custody and administration of $31.1 trillion across all asset classes. That compares to total bond market outstandings of an estimated $70 trillion
|Stu Taylor, Algomi|
“Custodian firms themselves have been trying to figure out how they might use their vast stores of customer data to benefit clients. But that data is subject to enormous sensitivity and close protection. The data cannot leave the custodian banks – they cannot sell it for example – and clients’ anonymity must be preserved. Now, rather than trying to send that customer data out, we at Algomi can deliver alerts to custody clients, but only if they elect to receive them in regard to all or parts of their portfolios. They can receive information on external market activity and interest in potential trades that is relevant to their holdings, with the protection that neither their position nor identity is disclosed. They can then choose to act on that or not,” says Taylor.
“For a custodian client of BNY Mellon, for example, any trade matching will only take place inside the BNY Mellon environment and through its dealing desk. This latest development, as with all our offerings, does not require bond data to be shared beyond its natural boundaries,” he adds.
Dominic Holland, head of fixed income electronic markets, arrived at Bank of New York Mellon one year ago from Deutsche Bank, where he had been closely involved in many of the e-trading initiatives to improve bond market liquidity. Part of his new remit is to find ways to deploy technology to better and more efficiently connect BNY Mellon’s custody customers to the fast-changing marketplace.
The challenge is to create workflows that preserve client confidentiality while still presenting relevant trade opportunities that might enhance investor returns. Working with an independent third-party such as Algomi, a data provider rather than a bank or a trading venue, was a key breakthrough.
“The aim of this initiative is to yield trade opportunities for our custody clients and the wider market, but it is not a trade execution service,” says Holland. “At present the workflows have not yet been finalized, but we expect to launch in early 2018. We are trying to keep it simple for now and retain optionality, but this all about enabling our custody clients to retain control over their own assets and provide confidentiality right up to the point of execution.”
As the new collaboration is built out, more custodians will likely be invited to join. BNY Mellon is especially dominant in custody in the US while HSBC is strong in Asia. A European custody bank might be next to come onboard.
“It may look unusual for a custody bank the size of BNY Mellon to launch a new service with another investment house, but we both see the potential value to our customers,” says Holland, “especially for asset managers that have been somewhat forced into buy-and-hold strategies in illiquid markets, rather than taking that approach willingly. It may in future allow a return to more active portfolio management.”
If rates continue to rise, investors might become keen to take up any service that helps them manage through the attendant volatility. The bigger the connected network, the better the chances of investors with big portfolios being able to move bonds in size without driving up the price of bonds they want to buy or depressing the price of bonds they want to sell.
|Niall Cameron, HSBC|
He suggests that it is an idea whose time has come. Building the data infrastructure from scratch would be a costly and risky investment for any single custodian, but Algomi has the foundations in place.
“Two years ago when we were developing FIX messaging protocols through Neptune, there was much less clarity around future secondary market regulation,” says Cameron. “That is now settled. We will be launching this after implementation of Mifid II, so can design it accordingly. It is important to stress that this is a messaging system – not a trade execution venue – for block trades above the size to which pre-trade transparency rules apply.”
Looking further ahead, he sees the potential for much more sophisticated uses.
“Much of the initial discussion has inevitably focused on existing holders of assets under custody being connected to potential bidders for their inventory. So an asset manager who acquired $30 million of a $1 billion new issue when he wanted $50 million, will have a much better chance of finding that extra $20 million, if he can send an alert through their custodians to holders of say $300 million of that particular deal. And the first stage of building this out will in large part be about routing messages to the right people at institutional clients – the portfolio manager or the trade execution desk,” says Cameron.
“To begin with, it’s possible clients will be slightly wary of being pinged too often with too many alerts. But potentially in the future asset owners could attach detailed messages to different positions held under custody. Messages could be: ‘I own $30 million of this bond and am interested in alerts from anyone wanting to sell another $20 million.’ Or ‘I will hold this bond until it has tightened to below 100bps over and then look to sell it.’ Or ‘I do not wish to trade in the last week in the quarter.’”
Another potential application to enhance returns for custody clients might be alerts on possibilities in securities financing markets.
“To start with we are talking about transferring bonds and messages such as: ‘I want to buy this bond, you own it’. But we may get to the stage where an owner could receive alerts that if it repos out for three weeks bonds that are now suddenly on special, it could earn extra basis points on them without selling at all,” says Cameron.