Over the course of the last decade, electronics have transformed the global markets: virtually all the world’s exchanges are electronic. Access to liquidity and the ability to execute in nanoseconds is routine. The electronic revolution in securities issues has led to greater efficiency, liquidity, price discovery, quicker execution, and productivity for all players: broker-dealers, institutions, and individual investors.
Notably absent from participation in this transformation has been the fixed income market, but that is changing. Driven by regulation, technology, and the need to compete, fixed income markets are catching up – if not soon to surpassing – the electronic capability seen in equities and purely fixed income asset classes.
The regulatory requirements mandated both in the Basel and Dodd-Frank regimes that lay out rules for the financial industry necessitate greater connectivity, transparency and access among fixed income players. Owing to regulation, upcoming trends will include a move from proprietary to agency-based execution, where an individual or a firm is authorized to executive on behalf of the principal, and a further tightening of spreads – all of which harbor well for a centralized connected solution.
In addition, from the competitive standpoint, the previous advantages reaped from bond market opacity are disappearing, meaning that the market is moving to become more efficient. Internet-based technology unavailable only a decade ago enables this efficiency, transparency, and connectivity. And, precisely because the bond markets are delayed entrants into technology, the technologies that are available and which are being deployed are already the most advanced.
Bonds behind the curve
One of the reasons the bond market has lagged behind is a resulting structural issues related to trading. Part of the problem resides in the sheer size of the market and the number of instruments available. In equities, a company has one stock available for trading. In the bond market, a company has different issues, released at different times, under different terms. This creates an illiquid market that is, by definition, ‘hard to trade’. Sourcing liquidity is not only difficult but has to be solicited and, until recently, the only way to find the other side of a trade was to make a number of bilateral phone calls.
Secondly, the way bonds are traded are simply not as easily understood by investors as equities and foreign currencies. But as investors increasingly see a need to diversify (evidenced by the decline in volumes in the equity markets), especially in light of today’s global market uncertainty, bonds become a “must have” in any portfolio. In addition, investors who are now holding large amounts of cash are trying to figure out what to do with it. One answer is bonds. For example, Americans invested $131 billion into taxable bond mutual funds through November 2011, with a concomitant net outflow of $115 billion from stock mutual funds.
What’s more, banks are no longer the sole liquidity providers, which has traditionally been the case. The result is a more liquid and competitive market. The buy side is getting bigger and trader intent will matter less in such an environment. What now matters is the desire to access liquidity and to execute.
The variables and trends in today’s environment call for a more sophisticated approach and technology meets this need, facilitates it, and drives it. The critical gap of the lack of a centralized, connected, and transparent market for interested parties worldwide to meet and transact is now being met. Such a centralized approach will generate maximum liquidity in one place without displacing current relationships but, rather, expanding on them and making them more efficient in time, access to liquidity, prices, and execution. People will not be displaced, but phones will be.
Delivering a centralized platform via technology to traders worldwide, regardless of type or motivation, will connect local market players to the entire universe of instruments available for trading. Local investors in Beirut, Riyadh or Dubai will be able to access any instrument, anywhere. And investors outside local markets will be able to transact in local issues. Interested parties will meet, regardless of time, location, or language.
Demographic issues are also pushing the equation. In the United States, the baby boomers are nearing retirement and are moving into bonds. In European securities, the desire for certainty mandates a move to more predictable asset classes. Younger traders, used to a world of Facebook and EBay, simply work through computers and mobile devices rather than phones, and will demand equivalency in their professional environment. The transformation is upon us.
HENRI CHAOUL is general manager of the Lebanon-based Master Capital Group