At the beginning of March 2014, APG became the first institutional investor backed by a pension fund to operate as an intermediated participant on BondMatch, the regulated multi-lateral bond-trading facility.
“The current regulatory environment in which trading and finding liquidity in fixed-income instruments is increasingly difficult, makes us look for innovative alternatives,” explains Thijs Aaten, managing director of treasury and trading at APG. “Current regulation is making using a bank balance sheet more expensive. As a result we see that banks are reducing their inventory of bonds for trading purposes. What makes the BondMatch trading platform different from other platforms is that it addresses this issue. Whereas most other platforms make the existing request-for-quote (RFQ) model more efficient by speeding it up and ‘electronifying’ the process, BondMatch introduces an order book and because of that removes the dependency on bank balance sheets. Therefore, we are supportive of the product and want to participate in shaping a possible future.”
As Aaten implies, many platforms in Europe have RFQ approaches. These include MarketAxess and Tradeweb, both of which are used by another Dutch pensions giant, PGGM. RFQ models use dealers as market makers. But according to Aaten, order books, which match users on a ‘price-time priority’ basis (that is, prioritising orders with the same price by their time stamp), may be the way forward.
“The challenge is in the competing business models – RFQ versus order book,” he says. “It is difficult for these two models to co-exist, and both have their pros and cons. We do not know what model will prevail, although regulation seems to favour an order-book model.”
Nathalie Masset, head of European debt markets at Euronext, which provides BondMatch, says that it will approach other pension funds in the near future.
“We’ve only had a couple of discussions with asset managers who are talking to us about their customers,” she says. “We have an action plan in the coming weeks and months to talk with a number of pension funds. The more active the participants in the buy-side, the more orders and more liquidity.”
Other platforms are also seeing the benefits of institutional asset owners. “We see strong demand from the buy-side and saw 33% growth from this sector year-on-year,” says Alyson Rodriguez, head of BondVision UK at MTS Group.
Constantinos Antoniades, founder and chief executive of Vega-Chi, the platform acquired by Liquidnet that offers convertible bonds and high-yield debt in Europe and the US, says it already has a number of pension funds clients. “We have also been in discussions with several pension funds and expect that in the next three to six months we’ll have more of them on board,” he adds.
Vega-Chi is designed to be anonymous. It allows larger players to exchange block size liquidity directly from each other to minimise market impact, with no one seeing their order except another trader with a contra order that matches their criteria.
“One of the things we hear from larger institutions is that their actions tend to be associated with market impact,” says Antoniades. “There is a lack of anonymity in the traditional over-the-counter market, and if they have to go through a dealer, they may not be able to do as large a size trade as they want.”
But for pension funds that are not ready for the electronic market, there are alternatives. Algomi provides information-matching solutions that aim to optimise fixed-income liquidity, for instance. It helps banks create what it calls “real-time social collaborations internally”.
Stu Taylor, chief executive, points out that only a tiny proportion of bonds, 1.2-1.3%, trade every day. In addition, because of bank capital charges that have to be applied, market making in credit instruments, and less liquid instruments in particular, have become a lot more expensive for banks. “The liquidity of electronic platforms tends to work reasonably well in those liquid bonds but, with everything else, it’s really poor and fragmented,” he says.
But unlike Aaten, Taylor also believes that neither the RFQ model nor the order-book model can really help when it comes to less liquid bonds.
“RFQ platforms tend to dominate in Europe and there have been attempts at order book,” he says. “With RFQ you will go to the dealer and say, give me a price on this. From the dealer’s point of view, he doesn’t want to own bonds, and he has only 30-40 seconds to line up a trade. With an order-book exchange-type model, the challenge is that a lot of the bonds just aren’t for sale today.”
Taylor believes that addressing the problem will be through increasing knowledge of the market, not platforms. “We advocate that the market needs better information management,” he says. “We supply information solutions to banks and try to build a landscape of who owns what and who is selling what. Then we help the banks connect the dots, both with their own sales people, and in terms of pointing out opportunities, without all the noise.”
This is a market in flux, but while it is unclear which models will dominate the industry, pension funds are busy exploring alternative sources of liquidity for their bond portfolios and strategies.