Market Volatility to Spur Electronic Trading in Fixed Income
Electronic trading in fixed-income securities will continue to grow despite, and even because of, the persisting volatility in flow credit, according to panelists at a Coalition Greenwich webinar on Electronification of the Credit Markets: Today and the Path Ahead.
The webinar was moderated by Kevin McPartland, Head of Research for the Market Structure and Technology group at Coalition Greenwich.
According to Tom Melvin, Director of North American Credit Trading at Invesco, e-trading in credit--which faced hurdles with the liquidity challenge of March 2020-- has evolved into “a more educated group of buy-side traders, well-honed sell-side shops with algorithmic trading, and cash traders squaring positions through the electronic market.”
“I think the numbers will rise as deals get larger. A $500 million deal in high yield was a decent size earlier. Now, if it's not a billion, it's not considered liquid. As new issuances get priced in a large format, we will see liquidity increase, which should help e-trading,” he says.
Growing Resilience to Market Shocks
Moreover, unlike before, when volatility saw traders switch from screens to voice to assess market color, today e-trading volumes are rising with market volatility. For instance, electronic flows in credit ETFs have witnessed an uptick with every pick-up in volatility.
In fact, Coalition Greenwich research shows that fixed-income e-trading is growing despite the approximately 36% year-on-year downtick in G10 global bank revenues in flow credit in the first half of 2022.
Says Eric Morrow, Head of Business Development, Credit Trading, J.P. Morgan: “The increase in volatility has tested our abilities to process and provide liquidity. That's been a positive outcome in that we built scale.” The bank has adopted a multi-asset, multi-protocol approach to provide liquidity on more avenues and enhance interactions with the buy side.
Rising volatility is also prompting J.P. Morgan to “turn over risk quicker to make sure we can provide better liquidity to clients. I think those who can do that the best will survive in the next three to five years,” says Eric Morrow.
Higher Velocity Impacting Liquidity Providers
Meanwhile, the increased velocity of e-trades, owing to the growth in credit ETFs, has “put more demands on liquidity providers to meet the demands of liquidity takers,” points out Phil Cichlar, Fixed Income Specialist at Jane Street Capital.
“We've seen massive growth from certain channels of the asset manager community. We are very comfortable with our RFQ [request for quote] protocols, but we're very cognizant of listening to our clients’ needs as their businesses move through challenging rate and credit environments,” he says.
According to him, velocity adds a different element to credit e-trading because of the vast number of CUSIPs. “That also allows liquidity providers to offer clients optionality around substitutes.”
Relationships Matter
That said, it is not as if relationships no longer matter with electronification. Invesco’s Tom Melvin believes it is important to talk to people to get the big-picture view of themes in the market.
Jane Street, too, is hearing more voice calls, albeit the conversations have become more nuanced. “It is important to strike a balance between leveraging technology and maintaining client relationships,” says Phil Cichlar.
Adds Eric Morrow, “We follow a two-pronged approach. We have the traditional high-touch business. But on the low-touch side, we have gotten a lot better at responding to bigger lists and sizes and moving risk faster. And we expect to get much better in future.”
Problem of Plenty
Nevertheless, it is a challenge to keep pace with innovations in e-trading and the multiplicity of platforms and protocols. “Right now, the market struggles with which space has the best information and most dealer access. As soon as the sell side figures out where the most buy-side eyes are, that platform will win the race,” says Tom Melvin.
In addition, the lack of standardization in protocols is inhibiting direct connectivity, according to Eric Morrow. “Why are there 50 ways to send an RFQ? Fragmentation is great, but it also creates problems and reduces the amount of electronification that we can actually get,” he says.
Looking Ahead
So, what’s next for electronification of the credit markets?
Players expect new entrants and innovations, including in execution management systems, to increase the pace of electronification. It is also expected to spread to fixed-income products, such as loans and collateralized loan obligations (CLOs).
However, as Phil Cichlar cautions, “Not every fixed-income asset class may see higher e-trading. Fragmentation in the electronification of fixed income may continue for the next few years.”