There is currently a great deal of discussion surrounding the cash credit market, as the industry considers various market structures. The way in which bond markets have developed – where the role of the dealer is to create buy-side markets – is a function of the number of instruments. However, regulatory changes and the increasing cost of holding inventory has fuelled buy-side concerns about the availability of liquidity under the current market structure, giving rise to an ongoing debate on alternative trading solutions.
In this environment, there has been substantial growth of electronic trading in vanilla credit products – an area in which strong liquidity remains. Since late 2010, electronic trading in cash credit has grown from around 20% of the dealer-to-customer market to nearer 50% – a remarkable jump, partly explained by the way market participants have been adjusting to new market realities.
In many cases, the buy-side execution function has been centralised and savings sought by cutting operational expenses – making the efficiency gains provided by electronic trading ever more vital. Coupled with a new, transparency-focused global regulatory regime, this trend has boosted demand for electronic liquidity. The sell-side responded by putting up liquidity of ever-greater quality, and so began a virtuous circle that now sees record-breaking volume in electronic bond trading.
Access to liquidity lies at the heart of successful e-trading platforms. In recent years, sell-side participants’ desire to win volume through e-platforms has led to significant improvements in the quality of electronic liquidity – and this trend is not necessarily reflective of the wider market. Tradeweb’s own European cash credit platform – with around 3,600 bonds traded every quarter – has broken records in liquidity metrics this year and continues to grow. Total volumes increased by 31% in the first half of 2013, while the ‘hit rate’ – the percentage of price requests resulting in trades and a demonstration that buy-side clients are highly confident in the liquidity available to them – was around 80%, both reaching record highs.
Certainly, there is an increasing perception among the buy-side that a growing proportion of sell-side liquidity is now being offered electronically. And alongside that perception comes increasing comfort in trading electronically.
Aside from the improving quality of liquidity, the feature pushing buy-side firms to adopt e-trading is the operational efficiency it offers. The request-for-quote (RFQ) system in use on many electronic platforms works on a similar basis to traditional trading practices, yet in a far more efficient manner from price discovery through execution, to post-trade processing and reporting.
The buy-side can tailor tickets to precise requirements and request prices from specific, disclosed dealers, as they were used to doing over the phone. But, crucially, they can request quotes this way from several dealers simultaneously, providing fast and transparent prices in an auction-like model. Putting dealers into competition like this optimises pricing efficiency in a way that is impossible through more traditional, time-consuming methods. What’s more, it helps the buy-side demonstrate best execution – which is critically important to institutional investors.
While legislators continue to finalise the exact rules under which markets will operate, it is clear that the RFQ model sits well with the stated aims of international regulatory bodies by providing greater transparency.
Electronic trading also benefits buy-side firms by offering integrated links to order-management systems (OMS) – reducing the need for manual intervention and therefore errors, while improving the trade processing workflow as trade details are electronically sent back to the OMS. More than 80% of European credit trades executed on Tradeweb are processed via integrated links.
Yet the dynamism of global credit markets demands constant innovation. The increasing number of index-tracking funds in the wider market has contributed to the growth in the use of list-trading functionality, which allows investors to rebalance portfolios quickly by executing multiple trades simultaneously. Trade volume through this tool on Tradeweb jumped by 83% in the first half of 2013 against the same period in 2012.
Through all these changes to global credit markets, the common thread is an increasing reliance on electronic trading. While the main driver stimulating the adoption of electronic trading may be the buy-side’s need for more efficient and cost-effective trade execution, improving liquidity quality and the impending new-look regulatory environment contribute greatly to its increasing ubiquity, as well.
Rupert Warmington is director of spread products at Tradeweb