Fixed income markets are back! With yields on 5-year US Investment Grade bonds back above 5%, some confidence that rate hikes will soon come to an end, and the outlook for equities being decidedly mixed given expectations for earnings, fixed income should see some meaningful inflows in 2023.
The recent volatility in bonds over the last 12 months has highlighted how much market structure has changed since the GFC. Whilst dealer liquidity remains an integral part of the market, it is clear that asset managers need to explore different ways to execute their business if they are to remain able to track their passive mandates or generate alpha in their active portfolios.
Fortunately, there are many innovations which could help fill this liquidity gap, however many trading desks are simply not in a position to make use of them due to their rigid and outdated technology platforms and lack of bandwidth to adopt new solutions. Increasingly, if you are unable to bring together broad data aggregation and analytics, multi-venue/multi-protocol trading connectivity and smart order routing technology, all wrapped in an integrated execution workflow, then you are in danger of being left behind.
Whilst there are many inefficiencies in rates markets which a more systematic approach can help with, it is in credit markets where the issues are most acute and where there is a huge opportunity for a game-changing solution that unlocks hidden liquidity and changes the way portfolio managers trade.
Before discussing what that might look like, let’s quickly review the current status of evolutions in bond markets.
Trading protocols
First, we have a number of trading protocol innovations which offer alternatives to the traditional disclosed RFQ-to-five approach. The large incumbent RFQ platforms have all rolled out a version of “RFQ-to-all” which is trying to expand the universe of potential counterparties, including non-traditional dealers, but with the disadvantage of leaking the information about your intended trade to the whole market.
In addition, there are dark pools and periodic mid-point auctions which aim to control information leakage and reduce transaction costs at the expense of being more patient to get filled. We also see central limit order book liquidity continuing to develop on certain ISINs, with new platforms and protocols specialising in certain order types or sub-asset classes cropping up on a frequent basis, not to mention the emergence of portfolio trading in recent years. This is all rather encouraging as it is obvious that a one-size-fits-all approach to fixed income trading no longer works.
"Most buy-side clients remain frustrated by the inability to digitise their full workflow in fixed income, and these problems manifest themselves most acutely when trading credit products.
Auto execution
Next we have automated execution tools which are embedded in some of the trading venues’ workflows. These generally allow traders to prescribe some high level rules which will automatically accept quotes for smaller transaction sizes, freeing them up from the drudgery of eye-balling every single execution to instead focus on the more difficult and larger items on their blotters. The limitation of these auto-ex tools is that they are complex to set up and will only execute on liquidity available on that particular venue. A necessary element of these tools is pricing data of sufficiently high fidelity for the trading rules to be effective.
Use of data
Of all the buzzwords that come up in FI trading circles, nothing beats “data”. This focus on better utilisation of data within trading workflows has spawned the emergence of companies focused on desktop interoperability enabling the sharing of certain data elements between different applications in the workflow. Whilst these approaches seem to facilitate a seamless integration of trading process components, they are often relatively superficial and limited in their capabilities and cannot be used to produce a full end-to-end execution solution.
Further, there are a number of new data providers offering fixed income data sets with a variety of different flavours - axe data, “AI-driven” evaluated pricing, pooled trade data sharing and curated scraped indicative levels. All of these data sets can be useful to the trading process, but they do not add any value in isolation. They need to be processed, normalised, cleaned and lastly integrated into the trading workflow. Most trading desks have started to explore these new data feeds, but the analysis is done offline and becomes a manual overlay to the execution process. There are tools available for this data analytics work ranging from the generic spreadsheet or BI applications, to specific fixed income tailored platforms. However, the problem of how you incorporate these analytical results inline with the trading process still remains.
Execution Management Systems
EMS solutions have been around for years in equities and in certain parts of the FX market, but have struggled to gain a foothold in fixed income. In theory they should be the piece of kit which coordinates the various elements of data aggregation, connectivity and smart order routing capabilities to provide a seamless execution experience. In practice, however, the differences in market structure between the bond trading world and equities is such that these platforms have struggled to deliver. It has proven too difficult for any of these providers to deliver a system which clients can use to handle all of the required execution workflows. The lack of a compelling solution to this problem results in most asset managers needing far more people to support their fixed income execution requirements than they do in the other asset classes, as they simply have fewer means to augment and automate.
Instrument selection - an OMS problem?
We hear all the time that execution desks receive orders in bonds which are difficult or impossible to trade. Without data about execution probabilities many portfolio managers are shooting in the dark when selecting instruments to express their view. Unless this data makes its way to the OMS they cannot hope to make better decisions, but the rigidity of these systems ensures this remains a pipedream. Furthermore, in most cases the optimal order type for a PM to pass for execution would be a “smart order” - one in which instead of selecting a specific ISIN, a set of criteria is expressed from which execution suggestions can be made and subsequently traded. Again, the rigidity of the OMS gets in the way here between the PMs and optimal execution.
So, despite all of these innovations and market structure changes, most buy-side clients remain frustrated by the inability to digitise their full workflow in fixed income, and these problems manifest themselves most acutely when trading credit products. This is why we developed Ediphy Credit, which sits alongside our government bond and derivatives execution solutions, to bring the disparate elements required to optimise and automate trading together in one integrated service.
Welcome Ediphy Credit
Ediphy Credit solves the specific problems traders face trading credit via a single browser-accessed platform. It combines large scale data aggregation and analytics capabilities with full connectivity to multiple venues and trading protocols in a holistic way. Data is integral at every step of the workflow. It is used on a pre-trade basis to assist our clients in the selection of what to trade and at what price, at the point-of-trade in our sophisticated smart order routing and execution strategy layer, and finally post-trade when evidencing best execution.
What’s more, this isn’t a costly enterprise software solution which will incur the usual pain and toil to install and integrate. It is a modern digital service delivered via the browser, akin to your online banking or even Netflix experience. There is no need to run FIX lines to the individual venues, we maintain all of that connectivity as part of the service. In fact, because Ediphy is delivered as a regulated service, not just software, our clients don't need to onboard and contract with multiple venues. All it takes is to onboard Ediphy once.
That list of trading platforms you never seem to get your organisation to prioritise is a thing of the past as you access them all by signing up with Ediphy. All data associated with every order execution is maintained and used to optimise the next trade - driving when, where and with which protocol to trade.
And we are only just getting started. Soon to be released functionality includes a hybrid high-touch/low-touch workflow enabling traders to get order context specific pre-trade data to assist with potential high-touch execution routes while maintaining the advantage of automated trading channels as opportunities present themselves. Alongside that we are adding tools to assist portfolio managers in their instrument selection, bringing information about the probability of execution of a particular bond and that of similar instruments into the portfolio construction process.
There are many ways to reimagine credit trading for the better. Ediphy is the manifestation of all those ideas, into a full service you can start using for free, in your browser, right away. Contact us today to onboard a new world of fixed income trading.
