Article 2 of 3: The first article in this series looked at the emergence of technology and workflow management tools that have only recently begun to be applied to the fixed income markets. In the second instalment of our series, I further explore the importance of both relationships and technology to access global liquidity pools.
As discussed in the first article, after years of resisting innovation in contrast to other asset classes, bond investors are finally embracing technological change. Ironically, the introduction of new trading protocols, venues and diverse data sets have introduced greater complexity to the market rather than making it easier to trade. In fact, instead of offering an efficient roadmap to navigate fragmented markets, sourcing liquidity and achieving best execution has become more difficult.
As we look ahead into 2022, expanding access to liquidity has never been more vital, but what is the optimum solution?
Although the technological advancements have been impressive with new cutting edge tools and sophisticated datasets, platforms and protocols, the value of human relationships should not be underestimated. Even in the digital world, there is no replacement for the acumen and insight of an experienced trader to provide advice and market color. A machine may point an asset manager in the right direction, but an experienced trader can help smooth the bumps and unearth the hard to find liquidity. This will become even more important in 2022 as markets remain volatile against a backdrop of rising inflation and interest rates.
Human judgement is particularly important in separating the signal from the noise. The tools may be there to collate and analyze the reams of data, but evaluating the quality of quotes and the chance of executing a trade requires a human touch and skillset.
Again, having the best of both worlds can help overcome the hurdles of assessing the quality of pre-trade market data which is often cited as one of the biggest challenges for asset managers. In much of the market, prices are indicative and not executable while securities that trade infrequently also have a wide range of indicative prices.
Evaluating post-trade data comes with its own set of issues. While the US has a robust regulatory reporting regime with TRACE, there is not the same level of transparency in other jurisdictions. There are several initiatives in different jurisdictions to create a consolidated tape, but for now no single solution yet exists.
Accessing global liquidity pools
It is one thing to sift through the market data and make a trading decision, and a completely different matter to access those prices. Most trades in the bond market are executed bilaterally and on a disclosed basis. If firms are not onboarded with a particular liquidity provider, it will be difficult to obtain those prices.
However, even if firms do have access to a provider, it will not solve all the issues. There is still a great deal of reliance on relationships built over years of doing business together and this will not diminish, even with the rise of electronic trading. In other words, digitalization will facilitate but not make the bond markets more easily tradeable.
As bond markets enter a long-forgotten era of rising interest and inflation rates, the benefits of humans and machines working side by side has never been clearer. Their symbiotic relationship has been evident over the past few months as volatility has come back with a force across all asset classes as central banks are in varying stages of redrawing their monetary policy roadmaps. The landscape has changed with liquidity draining even from the world’s most actively traded bond markets.
The result is that traders need the full gamut of tools at their disposal if they want to effectively and smoothly navigate a more jagged path.
This means not only deploying the latest technology and platforms but also skilled traders with deep relationships and knowledge, as well as a global reach. Blending the two together will uncover the deepest pockets of liquidity, as well as generate alpha, build value in client relationships and create operational efficiencies. This is a significant undertaking and not every firm has the resources or access to such a comprehensive suite of tools. This is why outsourcing trading has risen to the top of the agenda for many firms today. Our final article will examine the arrangements on offer and the checklist that they need to draw up when choosing a third party provider.
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