FIX-ing Liquidity in Fixed Income

Once the laggard asset class of Wall Street from a technology perspective, fixed income is now catching up with the rest of the financial industry. As single-dealer platforms continue to lose favor, investors are left scratching their heads as they try to find ways to capture this largely hidden asset class.

As explained in Bond Trading Resists Electronification, But for How Long?, a feature published in the November issue of Waters, a new wave of electronic bond trading platforms have come to market over the past few months to try and take advantage of the fact that broker-dealers have had to reduce their bond inventories due to higher capital requirements.

Even though there clearly have been a lot of efforts made to move toward the electronification of the fixed-income market, e-trading platforms are not the answer for all of the issues the market is facing. Instead, more simple acts of collaboration between desks, such as a shared messaging language, could make the difference.

A Common Protocol
Collaboration between buy-side and sell-side firms is rare enough, so industry participants hope that Project Neptune proves to be a coup.

The Neptune initiative managed to gather a group of about 30 lenders and investors, including 12 banks, to find alternatives to the existing communication channels for the bond market.

“The fixed-income market is very diverse and complex, with a whole lot of different instruments, and I don’t think that we will end up with a one-suits-all trading model.” Nathalie Masset, Euronext

Facilitated by Etrading Software, a London-based technology consultancy, the initial idea behind the project was to bring common standards to the industry in order to facilitate the exchange of pre-trade information between market participants. It resulted in the creation of a unified communication network using the FIX protocol, which, when fully implemented, will significantly improve the dissemination of information and help investors to connect to the right intermediary.

The network will be operated by Etrading and will distribute pre-trade information about available bonds from bank inventories and electronic trading platforms.

“Today, people are using a lot of different mechanisms to communicate, whether it is through emails containing spreadsheets, through Bloomberg chat, and so on, and it is very difficult for the buy side to then use this information in a sensible manner,” says Sassan Danesh, co-chair of the FIX Trading Community’s global fixed-income subcommittee, as well as managing partner at Etrading Software. “Consuming that information in a structured manner is very important so that the industry can then build tools to allow the data to be sifted efficiently. Neptune’s role is to provide the means for the industry to exchange inventory information in a structured manner, which then allows more sophisticated algorithms—outside of Neptune—to sift that data.”

Cheaper, Easier Access to Trade Information
The FIX protocol has been used in the equities space for years. It allows everyone to speak the same language, which makes it hard to believe the fixed-income market survived all these years without it.

“The file format for axes (the intent to buy or sell a security) distribution was not consistent before, which was quite costly for us, as we had to adapt to the different requests and the different formats,” says Stéphane Malrait, the global head of e-commerce, fixed income, credit and currencies at Societe Generale. “Also the delivery mechanism was not secured and we could not guarantee that the email attachment we sent would not circulate or go to someone who should not receive it.”

The Neptune working group is not looking to compete with existing platforms, but rather is looking for industry-wide adoption of FIX. The ultimate goal for the group, at least for now, is to create a hub that would link market participants in a cost-effective way.

“Instead of creating single points of contact for all of our clients, we want to create a hub so that we have only one point of connection,” Malrait says. “We would send information directly to the hub—where we would have the control mechanism in place that ensures we are sending this to the right people—and from there the information would go to the buy side.”

For the buy side, the Neptune hub will be the bridge to more liquidity, says Yann Couellan, head of fixed-income execution at AXA Investment Managers. AXA was a pioneer in developing proprietary tools to receive counterparties’ axes back in 2008, and Couellan says these systems will be significantly improved by the use of FIX standards, not only because the firm will be able to connect to more people in a more secure way, but also because the information quality will improve significantly.

Not a Trading Platform
This mechanism would make it cheaper and more secure for banks and asset managers because there would only be one point of connection, but it also sparked criticism as to whether this was an attempt by the banks to try and preserve their hegemony over bond trading.

But Malrait says the collaboration is not an initiative led by the banks to impose a particular model on the buy side. “We are not in competition with any other electronic trading platforms. The aim is not to create conflict; it is to create solutions to improve the workflow and transparency of the industry as a whole,” he says.

Although the buy side is holding most of the inventory today, most of the pre-trade information is coming from the sell side. As a result, in order to facilitate the distribution, quality and safe delivery of that data, both sides need to participate.

“It really is about sharing the information on a global level and that is why it is important that the sell side takes part in this,” Couellan says. “It is also a way for them to remain present in the process and to answer the needs and demands of the buy side, which is today holding most of the inventory.”

Agnostic But Powerful
Since Neptune only targets pre-trade information, it can technically be plugged into any kind of system and be agnostic in terms of the trading strategies chosen by buy-side firms.

“The fixed-income market is very diverse and complex, with a whole lot of different instruments, and I don’t think we will end up with a one-suits-all trading model,” says Nathalie Masset, director of European debt markets at Euronext. “Today, there are dozens of trading initiatives out there, some of which won’t exist in a few years, but there will always be several pools of liquidity using different trading models to suit the different needs. And Neptune aiming to develop a dedicated fixed-income communication protocol can really help the buy side to connect and communicate more easily with those pools.”

As Danesh explains, Neptune’s functionality has to be independent from any individual trading platform because it would make more sense to have it decoupled from the trading piece and then applied to the most efficient pattern. “Neptune itself should only be that communication network,” he says. “And once we have this sort of standardization that FIX can provide, we can create interoperability standards between networks and between all the different systems that both the buy side and sell side can use.”

Among the new trading platforms that have recently launched or are about to, many have been in touch with the working group to see if they would be willing to use the FIX protocol.

“Upon launching, our platform will be using the FIX protocol, as we know it is an important language,” says Paul Reynolds, CEO of Bondcube. “We think it is a very good idea and they would like us to connect to the network, which is a step forward for the industry.”

Collaboration Is the Answer
Some may call it the “equitization” of the fixed-income market, but for many it’s just the natural evolution of a market ecosystem toward electronification in the face of more regulation. Both forces are pushing more venues to be created and although only a few will remain, there will still be different trading paradigms to respond to the different needs.

As Masset explains, the percentage of over-the-counter (OTC) trades is set to decrease, partly because of regulations that are pushing for more trades to go on regulated platforms, but also because the industry needs venues to aggregate that liquidity in more centralized places.

Whether it is dictated by regulation or liquidity scarcity, SocGen’s Malrait says it is the first time in his career that he sees that many buy- and sell-side institutions collaborating for the good of the industry as a whole.

As the fixed-income market is becoming more technology-driven, those types of utility initiatives will be very important in the future, he says. “I think there are a lot of possibilities as to what we can do once this is done, but at this stage, everyone wants to focus on the first delivery, trying to see if we can work together, if we can create this hub, and if we can connect the order management system (OMS) site on the buy side. And only once we have achieved this, perhaps then we can start thinking about whether there is more we can do, but at the moment that is not the focus.”

And Neptune has already achieved quite a lot in bringing the two sides together. “I think every initiative that would bring market participants together can really make a difference,” Masset says. “Bondmatch was the first to be created on the back of one of those working groups and it is a good example of what the industry can achieve in order to answer its own needs.”

The final draft of the project is being reviewed by the FIX Trading Community’s global fixed-income subcommittee, and the industry can expect the project to be implemented in 2015, while hoping for more collaboration in the future.

Salient Points

• The liquidity issues in the credit market are not so much due to a shortage of liquidity, but rather a problem of access to it.
• This is more of a pre-trade problem that could be solved by informing the market of who is holding this inventory and who is interested in it through a unified communication network.
• Whether it is dictated by regulation or liquidity scarcity, the collaboration between the two sides will bring a level of standardization in the communication system, making it cheaper and safer for market participants to exchange their data.
• As the hub will only enable the exchange of pre-trade information, it can technically be plugged into any kind of system and be agnostic to the trading strategies chosen by asset managers.