Won’t Get Fooled Again:  Fixed Income Industry Regulations (2 of 2)

Won’t Get Fooled Again:  Fixed Income Industry Regulations (2 of 2)

Oct 10, 2017 6:08:00 AM
Picture of David Askin

David Askin

Complying with Regulations while Making Money

Redux of Part 1

In Part 1, we discussed the key regulations that are or are about to be most impactful for financial firms in the fixed income market.  We also took a holistic approach to these regulations enabling us to develop a unified framework based on the regulatory imperatives of increased transparency, better liquidity and risk mitigation.  This, in turn, established the central and critical role of access to accurate and timely price data, for price discovery that can assure compliance.

In this Part 2, we take the framework we identified in Part 1 and identify solutions.  In doing so we posit a central role for intelligent technology that breaks the mold of the older, siloed legacy platforms.  In doing so, these software platforms not only facilitate the access to the requisite data that help assure regulatory compliance but do so in a configurable way that neatly fits firm’s businesses and thereby help achieve a competitive advantage in the market that leads to increases in revenues, market share and profitability.


Exchange-Traded vs. OTC Markets

Previously, we argued that much of what is contained in the new regulations is appropriate for assuring the soundness and safety of market operations, despite the burdens they impose.  Unfortunately, some of these regulations also seem to assume implicitly that all instruments trade on a centralized exchange.  While this is generally true for most equities, it Is not the case for bonds, many derivatives, foreign exchange and commodities, which trade over the counter.  When it comes to price discovery, it is essential to recognize the significant differences between exchange-traded and OTC markets. 

One of the key distinguishing features between the two types of markets is size, especially size in terms of number of issues.

It might surprise some to know that in the US there now are only about 3,800 listed equities, down from over 7500 less than 20 years ago.  On the other hand, today there are over 2.5 million bonds in existence across the three major sectors --

"On any given day, 99% of these bonds do not trade at all"

Governments and Credit, Securitized Products (RMBS, ABS, CMBS, etc.) and Municipals.  Moreover, on any given day, 99% of these bonds do not trade at all (some of them almost never trade, once they have been bought when first issued).

The implication of this for price discovery is quite simple.  While there might be little question over the price of a share of, say, Amazon common stock at a point in time during the trading day, there likely is considerable uncertainty in determining what the correct price ought to be for an off the run high yield bond or an Agency CMO.  In addition, in the OTC market it is most likely that the available price discovery for regulatory purposes will be in the form of something like a quote, an axe, a bid list or a message, rather than a trade or a trade confirmation.


So What Are We To Do?

As we’ve discussed previously [See,  The Problem of Information Leakage in Fixed Income or Don't Miss This Fixed Income Market Change] there has been an explosion of available information over the last decade or so in the fixed income markets.  However, these data still are fragmented, not customized to individual situations and have proven hard to use effectively.  Moreover, within the world of fixed income execution, there is a significant dichotomy between the more traditional voice execution and electronic execution via ECNs and the like. 

There is still a tendency on the voice side of the aisle to view solutions involving the deployment of available data as proprietary information belonging to the two people on either side of the phone.  On the electronic side, the so-called solutions are more-often geared solely to driving execution (primarily for Corporates) to the provider’s trading venue.  Electronic bond execution also is highly concentrated in a relatively small number of the most liquid issues in a sector, leaving the less liquid bonds to trade via voice.  In addition, there are so many electronic protocols available that it is literally impossible for anyone to monitor all (or even most) of them in anything resembling real time.  In short, what is required is a solution that provides a timely view of the entire market for each bond, not just a small slice.  And it must do so regardless of the means of execution.

"The only way to solve the problem is with the efficient use of technology"

The only way to solve the problem is with the efficient use of technology, as the data needs have become too vast and too immediate to handle in any other way.  In addition, the application of such data is now required for a wide variety of different purposes, some of which are for the front-of back-office, while others are for the middle-office.  The latter is where regulatory reporting and compliance live. 

The data must also be readily communicated to a large set of end users and their applications.  Again, this means efficient technology and technology that can be customized to fit not only the relevant bonds of interest but also to the business need(s) under consideration.

The notions of timeliness and lot size also are important.  For compliance purposes for the fixed income industry regulations, timeliness need not mean real-time access to data, as it might for effective trade execution.  Instead, the price data that are available, whether based on trades or quotes, must also be associated with a time stamp, so one can determine when a particular price was available in the market.  Lot size is an important parameter in the bond markets, especially as one moves away from the liquid issues to the less liquid.  A bid or an offer for an odd lot typically will differ by quite a lot from one for an institutional lot size and even more so for large institutional lot size.  And all else equal, the further one moves from a on the run issue, the larger these differences become.


The Good, the Bad and the Ugly

There is no shortage of software platforms, some good, some less so.  The applications that work best are those that are designed to address specific pain points and to provide solutions to real world problems.

We all have seen offerings that focus mostly on sophisticated technology.  On the surface, they might look sexy.   For some of these it quickly becomes apparent that are focused more on the wishes of the developers to work in a cool language that they find interesting, than on the needs of the client.  They often incorporate only a limited understanding of clients’ business needs.  One might refer to these as software platforms that are desperately seeking an application.  Or more simply, just call them The Ugly.  

Somewhat better are applications that do a decent job on one or two of the functions that fixed income professionals need on a day to day basis.  Unfortunately, these seldom offer complete solutions.  This approach can work for complex and highly specialized problems.  In instances when this Is not the case, however, the result can be fragmented, inefficient and not cost-effective.  Although it might be harsh to call these The Bad, we’ll just refer to them as the Not So Good.

"The best software solutions require a holistic approach, based on a full understanding of the end users’ business needs."

We believe that the best software solutions require a holistic approach, based on a full understanding of the end users’ business needs.  They also integrate efficiently with the way each particular firm conducts its business.  In other words, the software is made to fit the people, rather than trying to make the people fit the software.  We refer to these as The Good.

At FixtHub, we have developed a platform that pulls together a variety of essential functions, based on a vast amount of market data from a variety of places.  As such, it provides a source-agnostic view of the entire market for trading fixed income securities.  At its core, the platform can provide its sell side and buy side clients the following:

  • Data Aggregation;
  • Data Visualization;
  • Real-Time Alerting Capabilities;
  • Relative Value Functionality; and
  • Counterparty Identification (Dealers only)

 Within the context of regulatory reporting and compliance, as well as for effective trading and portfolio management, access to all available market information at the time of the trade is essential.  Without this it is impossible to satisfy regulatory requirements properly, either with respect to pre-trade or post-trade activities.  In essence, the “good old days” of providing as evidence limited slices of information that have been manually and painfully extracted from a data-sparse environment, are over.



The increased burden of fixed income industry regulations applies to virtually all financial institutions.  In slow trading markets, this burden becomes even more acute, as firms try to deal with increased costs in a constrained revenue and profit environment.

Interest rates might rise, the yield curve might steepen and volatility might one day return and thereby help trading volumes to increase.  Yet, regulatory pressures are unlikely to ease any time soon, given the overriding concern of regulators to make sure that something like the financial crisis of 2008 never happens again.  Rather than deferring a solution by continuing to conduct business as usual, a more productive approach is to understand the regulatory reporting and compliance needs and to craft appropriate solutions.

In this two-part blog post, we have highlighted some of the more significant fixed income industry regulations that affect the markets, in attempt to identify a common thread that can lead to integrated solutions.  We believe we have done so. 

Transparency, liquidity and risk mitigation represent that common thread.  They create a need for a lot of accurate data, particularly price data.  This requires firms to generate the comprehensive access to price discovery for the bonds in which they traffic and to be able to deploy the data in a variety of targeted manners. 

Intelligent, customizable technology platforms now exist to do these things in cost-effective ways.  Having access to such a platform is a need to have not a nice to have capability.  This is not expected to change.



Technology can solve the problem, but should you buy a product that is already on the market or build a customized tool inhouse?

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