There is only one kind of shock worse than the totally unexpected: the expected for which one has refused to prepare.”— Mary Renault, The Charioteer
There is a massive change afoot in fixed income. A market that has historically been characterized as opaque and non-transparent is now one that, to its’ detriment, is awash with data. Prior, dealers had a significant information advantage relative to their customers, but now the fixed income market is marked by:
- An overwhelming explosion of information
- A leveling of information advantage
This more egalitarian access to huge quantities of largely unstructured data has unleashed a more significant, but much less discussed change, that has already greatly impaired dealers’ ability to do profitable business.
New initiatives and technologies with low thresholds to provide massive value have enabled increased access to information by more market participants. Somewhat paradoxically, these initiatives and technologies have further served to reduce many dealers’ margins (read: lower profitability) and their competitiveness. Some dealers have quietly taken steps to adapt to take advantage of these new market opportunities. Others have not and continue to operate their businesses in much the same way as they have for years. When a quorum of dealers embraces this change, there likely will be swift and painful repercussions. For those who prepare, there will be rewards to reap.
When a quorum of dealers embraces this change, there likely will be swift and painful repercussions. For those who prepare, there will be rewards to reap.
Historically, axes in the market have been viewed by manually searching unstructured email-like messages. While this has always been a slow, methodical endeavor, it also has proven problematic in finding relevant axes. Generally, traders have had to search constantly and proactively, not only to identify these axes but also to calculate the levels at which they would want and then try to execute the trades. For many, axes are simply missed. For others, axes are found after great effort, only to discover that the bonds have already traded away. Either way, this has been a logistical challenge with millions of bid and offers in these messages daily.
Ironically, this problem has been exacerbated by the explosion of fixed income electronic trading venues (primarily for Governments and Corporates) and the resultant and growing information overload. While electronic trading continues to grow, the bulk of this activity is concentrated in the most liquid sectors of the most liquid asset classes in generally small transaction sizes. More importantly, this also represents low-margin business for dealers.
Currently, fixed income electronic trading accounts for roughly 1/3 of trading volume and is growing at a metered pace. With 2/3 of the fixed income volume in higher margin voice trading, the stakes for competitively improving dealers’ businesses are massive. While we don’t believe that electronic trading will overtake all fixed income trading, the only way for dealers to greatly improve profitability in higher margin voice business, absent adding staff, is by smarter use of data via technology. Even better for dealers’ profitability, is the ability to operate nimbly as leading voice & electronic trading hybrid firms. Again, smart use of data remains key.
As fixed income electronic trading continues to gain traction, a by-product of the resulting increase in available information is the growing need to consume it more effectively. While many debate the adoption rate and ultimate market share of fixed income electronic trading, one thing should be abundantly clear: manually searching through large amounts of unstructured messages is in direct opposition to the trends supporting electronic trading’s ease of data consumption.
Why? Here are a few reasons why
- Aggregation: Whereas every new source of axes had been fragmented into information silos, electronic trading participants are increasingly embracing openness. There are many software firms that now aggregate electronic axes into one source for the end user. Electronic trading seems to be moving towards a one-stop location to view market data across transaction venues. On the other hand, unstructured data rarely commingle with other information.
- Market behavior: Traditionally, the fixed income market has been reactive, as market participants have pored through messages to find bonds that are interesting. However, the electronification of fixed income markets benefits from structured information. Structured information will transform the market to a proactive dynamic where tradeable axes aren’t searched for in large datasets, but rather are proactively displayed in real-time.
- Cost: Generally, people aren’t efficient at searching large datasets. When they do so it increases the cost of access to tradeable market data. Digital processes that search for and aggregate market data decrease the cost of finding and executing on tradeable axes.
Solutions for Unstructured Message Data
In acknowledgement of the disadvantages of unstructured market data, Project Neptune, a market utility, has sought to solve these issues. Neptune is attempting to standardize the format and delivery of dealer axes to the buyside. The goal is to decrease market data delivery costs for the sellside and improve axe consumption by clients. This is an explicit recognition that the buyside cannot effectively consume and utilize the millions of bids and offers it receives in messages each day.
How much traction has Neptune gained? In May 2017, Neptune announced that BofA Merrill joined the network to become the 22nd bank to disseminate axes via a standardized FIX protocol. Since May, 2 more dealers have been added to Neptune. While Neptune started in Europe, it is quickly expanding to the US and adding more asset classes. Expect this trend to continue and accelerate.
As further evidence that the market is moving away from unstructured messages, some fixed income software firms are taking these messages and structuring (aka “parsing”) dealer axes into formats that can be utilized in clients’ internal software. Not only is this market data structured, but it can be purchased in bulk so that both buyside firms and dealers can have a more comprehensive view of the market. In fact, if dealers want to see what competitors are doing, they now have access to their inside bids/offers. Many dealers are already doing this. The traditional dealer “game” of asking buyside firms for competitor levels has been eviscerated by technology.
In fact, if dealers want to see what competitors are doing, they now have access to their inside bids/offers. Many dealers are already doing this. The traditional dealer “game” of asking buyside firms for competitor levels has been eviscerated by technology.
What Does This Mean?
While electronic trading offers some obviously massive benefits, we aren’t suggesting the demise of voice. Voice trading still dominates and we don’t see this changing in the foreseeable future. In fact, we think voice proliferates with technology, especially for the less liquid fixed income instruments. Rather, we think that market participants need to improve their ability to consume the less liquid bonds that have historically lived in unstructured messages.
If successful, Neptune and other software vendors will make unstructured data obsolete. More importantly, the firms using these software technologies to gain access to the parsed and structured message data will achieve a significant competitive advantage over those that don’t.
As to those who question our premise, we would ask if they ever found an interesting axe only to discover that someone else had already traded the bonds before they could act. With market data in a standardized and accessible format, savvy market participants can utilize software tools that deliver attractive axes to them in real-time, while others are still manually searching. In fact, the firms that aren't using technology to route relevant axes will continue to see an increasing number of "already traded" axes.
What’s the Biggest Potential Market Shift That Not Enough Are Paying Attention To?
Unlike fixed income electronic trading, transforming unstructured messages to structured ones has small barriers, while the benefits are massive. These unstructured messages represent the majority of higher margin voice trading. Again, voice still constitutes almost two-thirds of fixed income trading. Therefore, we conclude that the stakes are high as gaining an advantage in voice will have a profound effect on profitability. The key to dominating in voice, where the higher-margin business transacts, lies with the firms that structure those messages and leverage technology.
Unlike the electronic trading venues, the parsers don’t need a network to be successful and the software behind them can be implemented relatively easily. Their use also gives a dealer a competitive advantage that doesn’t tip its hand to competitors.
Like it or not, change is coming. The real question: Are you ready?