November 2006

OK, let’s start with a fact….government bonds are the Kings of FI e-trading. Nothing controversial in that. However……..

With the advent of Liquidity Hub, including IRS at the core of the offering (waratah is of the opinion that US Treasuries are a bit of an add-on at this stage) and the “near-thing”of Swaps House – are OTC Derivatives, starting with vanilla swaps, really the future of FI e-trading?

Certainly you could debate the reasons behind the formation of Liquidity Hub, but generally I see this as a positive development to both sides of the market. A commitment to provide unprecedented liquidity in a major commoditised product has to be a good thing for clients……no?

Let me define the main clients here: Hedge Funds, Fund Managers (increasingly) and non-Price Making Banks. Corporates will eventually be a major client, however their goals regarding swap activity are (or should be) different to the above institutions – plus they’ll need a platform where they can deal in FX, Money Markets and Derivatives.

Although Swaps, and a few other OTC Derivatives, are offered electronically now, primarily via single dealer pages on Bloomberg & via the swaps platform on TradeWeb (talking B2C here), you could hardly say it has been a hit with clients.

One of the main problems has been the fact that only standard dates have been offered. So no broken dates*, no forward-start swaps and no switches/curve trades possible. Likewise there has been no functionality available to tidy up books. This is not to say that Liquidity Hub and whoever is chosen as the vendor/s will provide this from the get-go, but at least they appear to be making the right noises, so waratah hears on the grapevine. Having market maker buy-in, for one, is a major step forward and client feedback should help push them to offer all of the above in time.

So, returning to the question “are OTC Derivatives really the future of FI e-trading?” My answer is a definite yes! More and more IRS will move electronic. Before too many years pass, I see buyside swaps traders being in the same position as buyside government bond traders now… terms of “how did I ever do this over the phone?”.

Swaps will be the starting point, however I see single-name CDS as the real revolution in the future. As I blogged last week (see my home page), institutional credit in Europe has been an electronic failure. CDS should be the white knight once it is sufficiently mature in terms of standardisation and narrowing of bank margins…….some feel it is ready now. In terms of liquidity it is already ahead of the cash market.

To conclude, the current kings of FI E-trading, government bonds, will still be royalty in 2015, but maybe they’d have abdicated their top spot to OTC Derivatives – I also think, thanks to basis trading vs. Futures, Swap etc, their electronic volumes will have also grown, but that’s for another blog. Of course the complexity and size of some trades will be an issue electronically where derivatives are concerned. But for vanilla derivative products, such as Swaps (including many non-standard varieties) and single-name CDS, these are the jealous princes of FI e-Trading….ambitiously eyeing off the older man’s throne!

*Footnote: Indeed some banks do offer broken dates via BBG, however it remains a handful & all but 1 price them manually. They need to become mainstream.


Before I get started on my rant about Credit e-trading in Europe, can I please state two things:

1) Categorically I am a believer in credit for Fixed Income! Corporate Bonds, Subordinated debt, MBS, ABS, CDO, CLNs, FRNs (I don’t think of Supras, Agencies, Pfanbriefe etc as Credit in this context)….I believe, I truly do. Whether the spreads are far too narrow in relation to the risk is another matter and not for a blog on e-trading.

2) e-trading for Credit in Europe works for retail flow. Bloomberg do a great job of executing these essentially very simple trades, Reuters not quite as good a job,……because it is all about the price/yield the less than sophisticated end user wants. It is all about getting a massive number of small tickets done as efficiently as possible.

Now to the crux of this piece: E-trading for Institutional Sized Cash Credit in Europe has Failed.

You all agree? No? Is it only Market Axess & those at TradeWeb who joined for the Corporate offer that disagree? Or maybe the handful of institutional clients across Europe that do anything resembling a material % of their trades (not necessarily volume) electronically?

It is debatable as to whether it has failed or is failing. I prefer to be a bit more definite as I think the future doesn’t hold great hopes for the development of cash credit bonds electronically.

Liquidity is poor, for mostly obvious reasons, and getting worse – note the huge amount of M&A work that is being financed by various complex loan arrangements rather than bond or equity issuance. 2006 looks like being a very sad year for new corporate issuance….but have no fear bankers, your M&A guys have more than made up for it! As we all know, Liquidity is vital for a product to be sucessfully supported electronically.

The structure of the market isn’t conducive to e-trading. By this I mean the way institutions trade, spread vs. swap, spread vs. govt etc and of course the ovious fact that you have so many issues by so many different issuers with each issue often having a limted number of banks supporting it etc, thus rendering inventory as a major driver of liquidity. This is stating the obvious and yet many ECN’s continue to try and ram corporate bonds down people’s throat electronically, whilst essentially following the government bond model of CRFQ & trading on price.

The likes of Market Axess & now TradeWeb have clearly focused on the institutional side of credit. However MA have never been a raging success in Europe (The US is very different given the deeper and more mature credit market there) whilst the TradeWeb offering has been luke-warm  at best – in fairness it is still early days, but I don’t see it really taking off.

Can the Banks & ECN’s do a better job to meet institutional needs in this space? The answer is yes, but I can’t see them replicating phone/block trades to a satifactory degree…..primarily because of the liquidity factor – so ECN’s can continue to blame the Price Makers!

In my opinion, the real death-knell will be when single-name CDS goes electronic…..within the next two years. Liquidity will be far better, hedge funds will be more involved. Corporate Bonds will remain as important as they are now, to institutional investors, but I just don’t see how they are traded, electronically, developing enough over the same period.