Over the course of the last decade, electronics have transformed the global markets: Virtually all the world's exchanges are electronic, and access to liquidity and the ability to execute in nanoseconds is routine. The electronic revolution in securities issues has led to greater efficiency, liquidity, price discovery, quicker execution, and productivity for all players: Broker-dealers, institutions, and individual investors.
Notably absent from participation in this transformation has been the fixed income market. But that is changing. Driven by regulation, technology, and the need to compete, fixed income markets are catching up (if not soon to surpass) the electronic capability seen in equities and FX.
Paradoxically, the regulatory requirements mandated both in the Basel and Dodd-Frank regimes (including the Volker Rule), necessitate greater connectivity, transparency and access among fixed income players across asset classes. Owing to regulation, upcoming trends will include a move from proprietary to agency based execution and a further tightening of spreads - all of which harbor well for a centralized, agency, connected solution.
In addition, from the competitive standpoint, the previous advantages gleaned from bond market opacity are disappearing, meaning that the market is moving to become more efficient. Internet based technology, which was not available even a decade ago enables this efficiency, transparency, and connectivity. And, precisely because the bond markets are delayed entrants into technology, the technologies that are available and which are being deployed are the most advanced.
The bond market has lagged in technology owing to certain structural issues in bond trading. It would be too easy to simply lay off the problem on the culture of relationship based bond trading - because relationships will be important regardless of the mechanism of trading. Rather, part of the problem resides in the sheer size of the market and the number of instruments available for trading. In equities, a company has one stock available for trading. In the bond market, a company has different issues, released at different times, under different terms. This creates an illiquid market that is, by definition, hard to trade. Sourcing liquidity is not only difficult but has to be solicited, and until recently the only way to find the other side of a trade was to make a number of bilateral phone calls.
Secondly, how bonds are traded is simply not as easily understood by investors as are equities and FX, unless of course one holds to maturity. But as investors are increasingly seeing a need to diversify (evidenced by the decline in volumes in the equity markets), especially in light of today's global market uncertainty, bonds become a "must have" in a portfolio. In addition, investors, who are now holding large amounts of cash, are trying to figure out what to do with it. One answer is bonds. As an example, Americans invested a net $131 billion into taxable bond mutual funds through November 2011, with a concomitant net outflow of $115 billion from stock mutual funds.
Banks are no longer the sole liquidity providers, which has traditionally been the case. The result is a more liquid and more competitive market. The buy side is getting bigger. Trader intent will matter less in such an environment. What now matters is the desire to access liquidity and to execute.
The variables and trends in today's environment call for a more sophisticated approach and technology meets this need, facilitates it, and drives it. The critical gap of the lack of a centralized, connected, and transparent market for interested parties worldwide to meet and transact is now being met. Such a centralized approach will generate maximum liquidity in one place, not displacing current relationships but expanding them, and making them more efficient in time, in accessing liquidity and prices, and in execution. People will not be displaced, but phones will be.
Delivering a centralized platform via technology to traders worldwide, regardless of type or motivation will connect local market players to the entire universe of instruments available for trading. Local investors in Beirut, Riyadh or Dubai will be able to access any instrument, anywhere. And investors outside local markets will be able to transact in local issues. Interested parties will meet, regardless of time, location, or language.
Finally, demographic issues are pushing the equation. In the U.S., the baby boomers are nearing retirement and are moving into bonds. In European securities, the desire for certainty mandates a move to more predictable asset classes. Younger traders, used to a world of Facebook and EBay, simply work through computers and mobile devices rather than phones, and will demand equivalency in their professional environment.
The transformation is indeed happening. One company, Bonds.com, is one of a limited number of technology based firms seeking to address these diverse needs and constituencies as trading bonds transforms from paper and phone to computer based trading. Firms such as these are both responding to and building new mechanisms for bond traders worldwide and are ushering in a new era in global fixed income trading.
About the Author
Henri Chaoul, PhD, is General Manager of Master Capital Group (MCG) and is based in Lebanon. MCG is a financial firm specializing in online trading and brokerage services, offering self traders, introducing brokers and institutional clients, FX, CFDs, Futures, Options & Fixed Income Trade solutions.
© Capital ME 2012
