Trading desks today face the combined challenge of how to process massive amounts of market data, how to connect and route their orders to the appropriate venues and how to make best use of software, hardware and network connectivity to do it all in a timely manner. The days when a small reduction in latency could result in a big gain in revenues are gone. Nowadays, low latency is a pre-requisite to do business and we have to look beyond pure speed if we aim at achieving a competitive edge.

The first question the trader has to answer under MIFID II is whether a bond id sufficiently liquid that it will have to trade on a venue. ESMA will make that determination issuing specific guidelines. Traders have to check these guidelines to see if they can simply provide an OTC price or if they need to trade it on a venue. Under MIFID II, if the firm's market making activity an a bond is significant and frequent, then the firm must be registered as a SI in order to commit capital to the trade. If the firm instead operates on that bond infrequently and in small sizes, then it can just provide an OTC price.

if the bond does not meet internal criteria for capital committment or the firm does not want to trade it because it does not want to become an SI then the firm act as an agent, working the order on a RM or MTF or find the other side operating as a riskless principal or matched principal. Finally, it can operate as an OTF where customer-only orders interact.

In any case, transparency obligations will be enforced, according to the liquidity bucket of the bond. the trader has to check whether the bond can avail of a transparency waiver. If yes, after a compliance check, the price can be given to the client and Bloomberg's APA will hold the release of the completed trades as per ESMA's guidelines. If not, the price provided to the client has to be made public through an APA (Approved Publication Arrangement) simultaneously. Bloomberg will be an APA.

How are you getting ahead of impacts of recent regulatory proposals? Do you think there is more the buyside can do to increase their partnership in response?

Tighter regulations around the world have profoundly changed the financial markets landscape over the last few years. In many cases they have contributed to bring more clarity, in other cases they have created more ambiguity and uncertainty.

We have been very vocal during the latest approval process for MiFID II by taking an active role during the relevant consultation process as part of buy-side working group.

Our view is that, especially in Europe,  policymakers do not take on board enough feedback from the industry and that might lead to unintended consequences. This happens because often new legislation are initiated as an emotional immediate response to extreme crisis events or fraud cases. The risk in these cases is that the discussion around the table of policymakers might become too politicised and philosophical around topics that are sensitive for the public, such as ”more transparency is always good” and “less transparency is always bad”.

The risk is that the new legislation in the best case does not address the issue that was supposed to address and in the worst case it brings unintended consequence. In both cases it is a missed opportunity.

We envisage a greater role for supervisors, central banks and regulators towards creating a financial market environment where investors are protected by predatory behaviours and fair competition can be established among all market participants.

However, legislators should involve more the industry bodies in the consultation process in order to ensure that all interests are represented.

In Pioneer we have been very vocal during the latest approval process for MiFID II, both as part of buy-side working group and taking an active role during the relevant industry consultation process. With particular reference to transparency, we reiterate our view that we have always supported the idea that an appropriate level of transparency is necessary and beneficial. However, transparency should be a mean to bring certain benefits to the end investors and not an objective itself.

We remain convinced that transparency, especially in fixed income, is strictly correlated with liquidity and does not work for all markets. So we are in favour of the development of more transparent obligations as long as it enhances the price formation process and brings benefit to the end investors. In the more illiquid markets, instead, these challenges are harder to solve just imposing more transparency, because all you need is more liquidity, and in such markets more transparency might lead to the opposite effect.  We feel that the extension of pre-trade transparency without a proper calibration to the less liquid part of the market harm liquidity rather than improving it.

We feel that more efficient post-trade transparency with proper calibration to ensure market makers can absorb the risk and to protect liquidity across less liquid instruments might provide the transparency the market is looking for. )

Role of the OMS and EMS

As I said, given the technological development of the trading landscape over the last few years, OMS are critical to cope with the highly fragmented today’s market structure and to minimize  inefficiencies and risks connected with the trading process, with potential for an enhanced price discovery process and better quality of execution.

EMS (Execution management System) are key to enhance the execution functionalities of the OMS, increasing the percentage of trading volume executed electronically, enhancing traders’ capability to source liquidity from all available sources, from low touch and DMAs to algo trading and dark pools and to make that choice with the speed that today’s trading environment requires. The latter is critical when you have trading volumes in excess of 500 bil Euro yearly across all asset classes with a huge variety of requirements and criteria in terms of how best to achieve best execution. 

What are the biggest constraints or challenges you see in the future trading landscape?

With more than 250 bil $ under management and a global multi-asset trading desk with volume in excess of 1 trillion bil Euro yearly, it is easy to understand that liquidity is our main concern.

We have to deal with a huge variety of orders across a wide range of asset classes, each with a diversified set of requirements and criteria in terms of how best to achieve best execution. 

In order to succeed with such a large trading operation, we have to use a mix of orders, from brokers’ algos to low touch and DMAs, from dark pools to traditional high-touch orders. When liquidity is low and market impact might be significant, our approach is to source liquidity from all available sources.

In defining our execution strategy, liquidity is certainly the key element we consider. Our objective is always to build our positions trying to minimise market impact. Due to our large sizes we want to do that with the appropriate level of confidentiality to protect our investors. Therefore, the route and venues that we select depend really from the type of order that we are trying to execute. If we are working a large position, we feel our investors are better protected when trading away from lit venues, using high-touch orders with our most trusted counterparties, because our trading info are better protected as no one can see what you are trying to do and you can eventually get a decent part of your institutional block trade done. We know that if a large trade is spotted entering the market, our traders are open to abuse by HFT firms. It’s like playing poker where the other players else can see your hand. We have nothing against HFT, we just do not want to interact with them. These firms are making it fundamentally more difficult for institutional long-term investors to interact with the market and find liquidity at fair prices and generates volumes not liquidity.

If we are executing high ADV stocks, then we normally look at low-touch, electronic platform, DMA and algos, because we believe it can give us a better access to a fragmented liquidity and ensure the required level of anonymity.

How has regulation shaped your world?

I don’t know if anyone can ever define a victory something that will lead to further delay in implementing one of the most important piece of legislation since Mifid I.

But what we can say is that we were expecting it.

We have been very vocal during the latest approval process for MiFID II by taking an active role during the relevant consultation process as part of buy-side working group and through industry association. And I can tell you that during our meetings and trip to Brussels, we have realised how little the buy-side and sell-side was conflicted in this debate. At the end of the day, our shared concern was to ensure that we do not lose the ability to invest money efficiently for our clients.

Our view is that policymakers did not take on board enough feedback from the industry during the approval process. Usually the normal approach provides for intense consultation and evidence through lobbying. This was not the case in the current regulation reform approval process where it seemed that the nature of the process became soon highly politicised with most member countries and MEPs that took a philosophical approach on topic like “more transparency is always good, less transparency is always bad.

Unfortunately this is not true.

The risk is that the new legislation in the best case does not address the issue that was supposed to address and in the worst case it brings unintended consequence. In both cases it is a missed opportunity.

We envisage a greater role for supervisors, central banks and regulators towards creating a financial market environment where investors are protected by predatory behaviours and fair competition can be established among all market participants.

With particular reference to transparency, we reiterate our view that an appropriate level of transparency is necessary and beneficial. However, transparency should be a mean to bring certain benefits to the end investors and not an objective itself.

We remain convinced that transparency is strictly correlated with liquidity and does not work for all markets. So, we are in favour of the development of stricter transparent obligations as long as it enhances the price formation process and brings benefit to the end investors. We feel that the extension of pre-and post-trade transparency requirements without a proper calibration to the less liquid part of the market will harm liquidity rather than improving it.

We feel that a post-trade transparency regime supported by a level of calibration capable of ensuring that market makers can absorb the risk and to protect liquidity across less liquid instruments might provide the transparency the market is looking for.

It is pointless to say that we are not against transparency. However, if the so-called “equitization” of fixed income market means forcing full transparency, irrespective of the asset class traded, liquidity, the type of order or the market conditions, then this is wrong, simply because it will deteriorate the price formation process.

In the more illiquid markets, the extension of pre-trade transparency without a proper calibration to the less liquid part of the market could have a number of undesirable effects, such as:

·         harming liquidity, as market makers will either widen their spreads (increase cost of trading) or step away from the market (liquidity deterioration). Dealers that win a trade responding to an RFQ on an MTF will see their ability to hedge the position compromised by the information leakage to the losing dealers that can now take the contrarian market position.

·         Increasing  the cost of funding for all issuers as they have to offer a premium over secondary market (which in turn might already be trading at a wider spread in high volatility time)

·         Agency model will concentrate trading only in liquid debt (issue for SME and project financing), de facto impacting the ability of SME and Infrastructure Projects to access financing, raise capital, fund their activities, grow and create jobs

I think we make no mistake if we say that the main target of MIFID I was to bring down the cost of transaction for investors and secondly, to facilitate the creation of a large secondary market which could eventually enhance liquidity.

There appears in fact to be a public consensus that while MIFID I was a success as competition became a reality, there were a number of side-effects:

1)      THE FIRST ONE IS LIQUIDITY: MIFID I is now widely recognised as a complete failure in terms of enhancing the level of liquidity in lit markets and instead had a devastating effect for liquidity. It has increased fragmentation of liquidity across more trading venues, which has made it more difficult for the buy-side to understand where the liquidity is. Where before there was a single provider of liquidity, now we see a proliferation of alternative venues, both lit and dark.

So MIFID 2 review was an opportunity. An opportunity to learn from the mistakes and counter effects brought my MIFID I and eventually ensure that financial markets serve European investors’ needs.

 We believe that MIFID II should restore truth in Europe’s financial markets, by encouraging fair price formation, efficient capital allocation, returns for savers, risk mitigation tools and eventually market that deliver social benefits because let’s not forget that European citizen do finance the real economy through their investments in pension funds, UCITS, Insurance plans.

-          significant reduction of liquidity in the secondary market

-          which might in turn lead to widened spreads

-          greater cost of trading

-          lower liquidity across exchanges

-          Eventually worsening significantly the quality of the execution for the end customers, the long-term savers.

What we said to the regulators in Brussels was that we needed to keep the interests of long-term investors at the centre of discussions . We have brought to the attention of the regulators three main concerns:

Liquidity in fixed income markets

Over the past few years, much has been written about bond market liquidity. In this brief presentation, we will go through some of the main set of data that have been cited by several reports as being the main causes of liquidity reduction. 

-          The decline in broker-dealer inventories

-          The decline in turnover by comparing the amounts of bonds outstanding to bond trading volumes

-          The increase in corporate bond issuance

-          The growth of the asset management industry

Notwithstanding the above, we feel that the above data ignore several other factors and constraints that might drive the decisional process of market participants in different directions, in particular:

1)      Liquidity is not free.

Inherent in the price of fixed income assets is the concept that liquidity has a cost. The cost of liquidity can increase when immediacy is needed and even more so if immediacy is demanded when liquidity is scarce. An increased cost of liquidity might mean losses for some investors but, at the some times, it might mean an investment opportunity for some other market players, who can see a market sell-off as a buying opportunity. This circumstance, introduce the next element often forgotten in liquidity analysis:

2)      Many asset owners have unrelated investment objectives and constraints that drive their behaviour in disparate ways

During the spike in volatility that occurred on the high yield market in December 2015, mutual funds redeemed almost $10bil of assets from high yields funds. However, the HY market did not register a net negative net flows, for the simple reasons that while mutual funds were selling, other institutional investors decided to increase their HY allocation, viewing the sell-off as an attractive buying opportunity. Hence, while increased liquidity cost might reduce investment returns and generate losses for some, it might generate profit for someone else. The fact that there are winners and losers in the market clearly shows that we are facing market risk not systemic risk.

3)      Diversity of asset owners

While the asset management industry has grown in size, the majority of fixed income assets are owned by long-term low turnover investors, such as fund managers, pension funds and insurers. These firms have all different objectives related to return, risk, investment horizon, liability structure, tax regime and liquidity needs. It is therefore unlikely to assume that they will all react in the same way when facing a market event.

4)      Bond  turnover data often omits the growth of ETF market as a source of liquidity

We think that these data reflect a structural change to market liquidity that is encouraging market participants to evolve and adapt their processes and systems.

What to do:

1)      Enhance trading capabilities

In Pioneer, over the last few years, we have made a significant investment in technology to enhance our trading capabilities through the deployment of a global integrated order management system, an embedded execution management system, the deployment of the Global Trading Desk, the enhancement of our connectivity platform and the development of a comprehensive set of trading tools aimed at improving our execution capabilities.

2)      Adapt the investment process

We are not alone in the firm. Portfolio managers have also adapted their investment process to account for reduced market liquidity and our risk management function has also built new tools to enhance its monitoring of liquidity risk in our portfolios. The inability, or worse, the unwillingness to adapt to the change in market structure and liquidity through stronger trading capabilities, thoughtful investment process and more robust risk management tools can lead to significant issues.

3)      Recognise and accept liquidity as a cost and represent market risk, not systemic

4)      Modernise fixed income market structure

Market participants have increasingly looked at new ways to become more efficient at aggregating fragmented sources of liquidity and to find smarter solutions to execute trades. This has resulted in the development of electronic platforms. All dominant electronic multi-dealer platforms, such as Marketaxess, Bloomberg, Tradeweb are all trying to discover new way of connecting people.

Besides, new initiatives have been launched aimed at offering new trading protocols and innovative solution to find liquidity by directly connecting buyer and sellers with a much lower level of intermediation.  What follows is a non-exhaustive list of initiative that are gathering attention from market players:

-          All-to-all

-          Buy-side to buy-side: One of the main problems of B2B trading network is determining the price for a bilateral exchange between two buy-side participants in the absence of a multilateral market price which could be considered ‘fair’ to both sides and agreed as fair by the regulator. In the equity world, this problem is solved by the use of the mid between the best bid and offer (BBO) across all the marketplaces in which that equity trades – the European Best Bid and Offer (EBBO). But this is not available for bonds. Blackrock, which launched a B2B platform in 2012, announced a year after that it was discontinuing its attempt to offer such a service.

-          Liquidity aggregator: Neptune

-          Call Market: this is also the way in which most European stock markets including the LSE set opening and closing prices. It simply consists of a “periodic market auction”. Periodic auctions, rather than continuous auctions, aggregate the buy-side’s demand for liquidity over a period of time into a short trading session. In this model, it is thus much more likely that a match can be found for bonds which trade relatively infrequently. In addition, often if there is no match, the provider of the ‘sessions’ platform, may be willing to commit capital and take the other side.

-          Hybrid system: these are system that use both electronic trading and voice assistance. It operates in a similar way to a limit order book in many regards. It requires two parties to agree a price at which they will trade, but the platform provider also advertises the trade to the market for a brief period. More often than not, other participants join in and the trade goes through in larger size than the amount agreed between the two original parties. This system brings in people who are neither traditional takers or makers but a third group which is opportunistic: people who want to see a trade happening first and will then go along. Order book trading can also be supplemented by periodic auctions when there is insufficient liquidity in the continuous trading order book.

We are probably at a stage in the electronic market development where new trading platforms will continue to be launched at regular intervals. But we will also see a Darwinian process whereby many of them will fail to gather sufficient business and will disappear.

For liquid bonds, exchange type trading may become more common.

Where that liquidity is not there, a continuous market with pre-trade transparency will not work and perhaps even periodic auctions may not solve the problem. Thus brokers/dealers capital facilitation might be needed at an higher cost. Institutional LIS crossing network will succeed and buy-side will probably shift toward a more active role in price making rather than just participating as a price taker.

5)      From price takers to price makers

If we consider that in excess of 90% of bonds inventory (some say even 99%) is held by institutional bond investors, it is easy to understand that the asset management industry is holding the key to address the liquidity conundrum. Those large dormant inventories held by asset managers, pension funds and other institutional investors are a natural source of liquidity that can be used as an alternative to the now greatly reduced capacity of broker/dealers to use balance sheets to facilitate clients’ trades. How can that be achieved? By shifting from a pure price takers role to a price makers one, a role that large asset managers like us have to start considering.

What would be the risk and the opportunities connected to such a model change? The reward would be to take out the spread instead of paying the spread. A price maker in fact buy at the bid and sell at the offer, therefore  the net result will be a significant improvements in terms of pricing and eventually performance for the end client. Making prices does, of course, present a risk of losing money by getting the price wrong or having unwanted positions. However, asset managers are much better equipped from to manage inventories for a number of reasons:

-          Brokers/dealers have their trading books highly mismatched from a maturity perspective’ since they finance long-term bonds with overnight repo. In contrast to broker/ dealers, asset managers do not have to re-finance their long maturity inventory every day in the overnight repo market and therefore do not have to bear the risk of not being able to roll-over repo during a liquidity crunch.

-          Fund managers do not need to be concerned with collateral or haircuts

-          Asset managers are not subject to the Basel III Liquidity Ratios, which also raise the cost of broker/ dealer market-making. Their portfolios are already funded by their fund investors so they are better placed to provide liquidity to each other than are highly leveraged intermediaries.

We believe that if the buy-side offered liquidity services successfully, it would have private and public benefits. The private benefit would be to create another source of alpha for clients. The public benefit would be a shift of liquidity provision from highly leveraged firms to unleveraged funds which would  likely reduce systemic risk.

And this is not only true in the secondary market, but would bring huge benefits to the functioning of the primary market as well, which, as we know, is one of the main source of alpha for asset managers over the past few years. Over the last few years primary markets went through significant change in terms of how the underwriting system works. Traditionally, in primary deals, lead managers buy the whole issue from the corporate before it had been sold to investors, thus taking on price risk prior to distribution. When this happens, broker/ dealers (investment banks) commit substantial funds, hence regulatory capital, to the distribution process, which under the new Basel regulatory framework would become much more costly. Today the majority of the deals eomply the so-called ‘pot’ system, where only when sufficient orders have been collected to cover the whole amount of the issue (the book), the deal is finally priced. Only at this point, when there is virtually no risk of loss, the new issue is finally launched. Bonds are then allocated to clients of all underwriters by the ‘book-running/lead manager. In other words deals are no longer launched until they are already placed i.e. effectively bought by investors. So the underwriting risk has largely been taken away from the dealers. On the other hand, buy-side asset managers find increasingly herder to understand how to play a more meaningful role in this market as the rules of engagement of the process of allocation are not always completely clear and transparent. An alternative would be for the buy-side to work with the sell-side by joining distribution syndicates and acquiring their positions directly from an issuer. In such case, the investment bank would undertake only pricing and issue management rather than also providing capital commitment. As in direct buy-side participation in the secondary market, this would allow institutional investors to buy at the syndicate buying price (bid) rather than at the syndicate selling price (offer). It would, of course, mean taking on a different role and taking on additional risk but in a similar way to institutional equity investors participate as new issue sub-underwriters. For those that would undertake these activities successfully, it would be another way of successfully generating alpha.

The move to a more active role of asset managers in the market making space is less far than we think.  In fact, while in dealer markets only dealers can provide quotes, on an order-book markets any trader accepted on the system can enter limit orders and can thus potentially offer liquidity to other traders (by being a price maker). As a result, in an electronic order-book driven market, dealers and buy-side are, in terms of the types of order they may enter, no different from each other. On an all-to-all platform both can enter limit orders (make price) as well as market orders (take prices).

Will institutional bond investors enter the market as ‘dealers’? we don’t know but certainly tis is an opportunity for asset managers. Certainly the skills required to price securities are very different from those of the traditional institutional buy-side trader, whether in equities or bonds. It requires skills, competence and platform. It require a move to a multi-asset trading desk and a global integrated trading IT infrastructure that is capable of supporting the complexity, and related risks, of such activity.

We are concerned about the new equities-like transparency rules for non-equity products that are being introduced under Mifid2. These rules means that for some instruments, prices will need to be made public as well as the details of the executed deal. Other securities that previously traded over-the-counter will be forced to onto organised venues. We are concerned that too much transparency will harm our ability to trade effectively in illiquid items, potentially bringing a further element of strain on liquidity in these markets. We understand that finding that right balance in transparency obligations capable of supporting the price formation process and at the same time encouraging the provision of liquidity is a difficult equation to achieve. However, we feel that the unintended consequence of setting wrong transparency obligations might be significant, especially in an market crisis event. 

All-to-all:

Buy-side to buy-side: One of the main problems of B2B trading network is determining the price for a bilateral exchange between two buy-side participants in the absence of a multilateral market price which could be considered ‘fair’ to both sides and agreed as fair by the regulator. In the equity world, this problem is solved by the use of the mid between the best bid and offer (BBO) across all the marketplaces in which that equity trades – the European Best Bid and Offer (EBBO). But this is not available for bonds. Blackrock, which launched a B2B platform in 2012, announced a year after that it was discontinuing its attempt to offer such a service.

Liquidity aggregator: Neptune

Call Market: this is also the way in which most European stock markets including the LSE set opening and closing prices. It simply consists of a “periodic market auction”. Periodic auctions, rather than continuous auctions, aggregate the buy-side’s demand for liquidity over a period of time into a short trading session. In this model, it is thus much more likely that a match can be found for bonds which trade relatively infrequently. In addition, often if there is no match, the provider of the ‘sessions’ platform, may be willing to commit capital and take the other side.

Hybrid system: these are system that use both electronic trading and voice assistance. It operates in a similar way to a limit order book in many regards. It requires two parties to agree a price at which they will trade, but GFI then advertises the trade to the market for a brief period. More often than not, other participants join in and the trade goes through in larger size than the amount agreed between the two original parties. This system brings in people who are neither traditional takers or makers but a third group which is opportunistic: people who want to see a trade happening first and will then go along. Order book trading can also be supplemented by periodic auctions when there is insufficient liquidity in the continuous trading order book.

We are probably at a stage in the electronic market development where new trading platforms will continue to be launched at regular intervals. But we will also see a Darwinian process whereby many of them will fail to gather sufficient business and will disappear.

For liquid bonds, exchange type trading may become more common. Where that liquidity is not there, a continuos market with pre-trade transparency will not work and perhaps even periodioc auctions may not solve the problem. Thus brokers/dealers capital facilitation might be needed at an higher cost. Institutional LIS crossing network will succeed and buy-side will probably shift toward a more active role in price making rather than just participating as a price taker.

Can the buy-side make prices?

Corporate bond dealers in the US are said to have reduced their corporate bond inventories from a level of around $250billion in 2007 to only around $50billion in 2012. With so little inventory and the cost of holding that inventory so much higher in terms of capital, the new environment is one in which balance sheet facilitation of client trades is less attractive to brokers relative to agency broking than in the past.

If we add that in excess of 90% of bonds inventory (some say even 99%) is held by institutional bond investors, it is easy to understand that we, the asset management industry, are holding the key to address the liquidity conundrum. Those large dormant inventories held by asset managers, pension funds and other institutional investors are a natural source of liquidity that can be used as an alternative to the now greatly reduced capacity of broker/dealers to use balance sheets to facilitate clients’ trades.

How can that be achieved? By shifting from a pure price takers role to a price makers one, a role that large asset managers like us have to start considering. What would be the risk and the opportunities connected to such a model change? The reward would be to take out the spread instead of paying the spread. A price maker in fact buy at the bid and sell at the offer, therefore  the net result will be a significant improvements in terms of pricing and eventually performance for the end client.

Making prices does, of course, present a risk of losing money by getting the price wrong or having unwanted positions. However, asset managers are much better equipped from to manage inventories for a number of reasons:

-          Brokers/dealers have their trading books highly mismatched from a maturity perspective’ since they finance long-term bonds with overnight repo. In contrast to broker/ dealers, asset managers do not have to re-finance their long maturity inventory every day in the overnight repo market and therefore do not have to bear the risk of not being able to roll-over repo during a liquidity crunch.

-          Fund managers do not need to be concerned with collateral or haircuts

-          Asset managers are not subject to the Basel III Liquidity Ratios which also raise the cost of broker/ dealer market-making. Their portfolios are already funded by their fund investors so they are better placed to provide liquidity to each other than are highly leveraged intermediaries.

We believe that if the buy-side offered liquidity services successfully, it would have private and public benefits. The private benefit would be to create another source of alpha for clients. The public benefit would be a shift of liquidity provision from highly leveraged firms to unleveraged funds which would  likely reduce systemic risk.

And this is not only true in the secondary market, but would bring huge benefits to the functioning of the primary market as well, which, as we know, is one of the main source of alpha for asset managers over the past few years.

Over the last few years primary markets went through significant change in terms of how the underwriting system works. Traditionally, in primary deals, lead managers buy the whole issue from the corporate before it had been sold to investors, thus taking on price risk prior to distribution. When this happens, broker/ dealers (investment banks) commit substantial funds, hence regulatory capital, to the distribution process, which under the new Basel regulatory framework would become much more costly. Today the majority of the deals eomply the so-called ‘pot’ system, where only when sufficient orders have been collected to cover the whole amount of the issue (the book), the deal is finally priced. Only at this point, when there is virtually no risk of loss, the new issue is finally launched. Bonds are then allocated to clients of all underwriters by the ‘book-running/lead manager. In other words deals are no longer launched until they are already placed i.e. effectively bought by investors. So the underwriting risk has largely been taken away from the dealers. On the other hand, buy-side asset managers find increasingly herder to understand how to play a more meaningful role in this market as the rules of engagement of the process of allocation are not always completely clear and transparent. An alternative would be for the buy-side to work with the sell-side by joining distribution syndicates and acquiring their positions directly from an issuer. In such case, the investment bank would undertake only pricing and issue management rather than also providing capital commitment. As in direct buy-side participation in the secondary market, this would allow institutional investors to buy at the syndicate buying price (bid) rather than at the syndicate selling price (offer). It would, of course, mean taking on a different role and taking on additional risk but in a similar way to institutional equity investors participate as new issue sub-underwriters. For those that would undertake these activities successfully, it would be another way of successfully generating alpha.

The move to a more active role of asset managers in the market making space is less far than we think.  In fact, while in dealer markets only dealers can provide quotes, on an order-book markets any trader accepted on the system can enter limit orders and can thus potentially offer liquidity to other traders (by being a price maker). As a result, in an electronic order-book driven market, dealers and buy-side are, in terms of the types of order they may enter, no different from each other. On an all-to-all platform both can enter limit orders (make price) as well as market orders (take prices).

Will institutional bond investors enter the market as ‘dealers’? we don’t know but certainly tis is an opportunity for asset managers. Certainly the skills required to price securities are very different from those of the traditional institutional buy-side trader, whether in equities or bonds. It requires skills, competence and platform. It require a move to a multi-asset trading desk and a global integrated trading IT infrastructure that is capable of supporting the complexity, and related risks, of such activity.

Given the above, the dominant electronic multi-dealer platforms, such as Marketaxess, Bloomberg, Tradeweb are all trying to discover new way of connecting people.

What follows is a non-exhaustive list of initiative that are gathering attention from market players:

All-to-all:

Buy-side to buy-side: One of the main problems of B2B trading network is determining the price for a bilateral exchange between two buy-side participants in the absence of a multilateral market price which could be considered ‘fair’ to both sides and agreed as fair by the regulator. In the equity world, this problem is solved by the use of the mid between the best bid and offer (BBO) across all the marketplaces in which that equity trades – the European Best Bid and Offer (EBBO). But this is not available for bonds. Blackrock, which launched a B2B platform in 2012, announced a year after that it was discontinuing its attempt to offer such a service.

Liquidity aggregator: Neptune

Call Market: this is also the way in which most European stock markets including the LSE set opening and closing prices. It simply consists of a “periodic market auction”. Periodic auctions, rather than continuous auctions, aggregate the buy-side’s demand for liquidity over a period of time into a short trading session. In this model, it is thus much more likely that a match can be found for bonds which trade relatively infrequently. In addition, often if there is no match, the provider of the ‘sessions’ platform, may be willing to commit capital and take the other side.

Hybrid system: these are system that use both electronic trading and voice assistance. It operates in a similar way to a limit order book in many regards. It requires two parties to agree a price at which they will trade, but GFI then advertises the trade to the market for a brief period. More often than not, other participants join in and the trade goes through in larger size than the amount agreed between the two original parties. This system brings in people who are neither traditional takers or makers but a third group which is opportunistic: people who want to see a trade happening first and will then go along. Order book trading can also be supplemented by periodic auctions when there is insufficient liquidity in the continuous trading order book.

We are probably at a stage in the electronic market development where new trading platforms will continue to be launched at regular intervals. But we will also see a Darwinian process whereby many of them will fail to gather sufficient business and will disappear.

For liquid bonds, exchange type trading may become more common. Where that liquidity is not there, a continuos market with pre-trade transparency will not work and perhaps even periodioc auctions may not solve the problem. Thus brokers/dealers capital facilitation might be needed at an higher cost. Institutional LIS crossing network will succeed and buy-side will probably shift toward a more active role in price making rather than just participating as a price taker.

About technology

If you look at how the trading environment has changed over the last ten years, it’s exciting. Ten years ago most trades were done over the phone. Today, we’re talking about microseconds, HFT firms that employ military technology to maximise their trading speed; that’s how much the market has changed. Millions of trades happening every second. Once you accept that the trading environment has changed so dramatically, technology has to be part of your life. With the worsening liquidity situation in the market and the fragmentation due to the stricter regulation environment, technology has to play a major part in our investment strategy. Over the last three years, at Pioneer, we have made a significant investment in technology, and last year we completed the deployment of our global order management system, Aladdin, which is an global Order management System (OMS) with an integrated execution management system, with all the relevant connectivity.

Today, we are connected, via FIX, to all major electronic platforms; Tradeweb, Market Access, Bloomberg, TSOX, BondVision. With the volumes and sizes we trade, we need to leverage on as many sources of liquidity as possible and in this type of environment, only technology is capable of giving you that possibility. The fragmentation of liquidity that has been generated by legislation, regulation and the change of market structure, has now made it impossible for people sitting on a desk, to go and look at every single venue. You need to have your order management system, your connectivity to exchanges, your smart order routing, an optimiser that allows you analyse the quality of execution that you have in every single venue, and so on.

In 2015, we have also completed the implementation of the Global Trading Desk, which is one of the reasons we were given the ‘Best Multi-Asset Trading Desk of the Year’ award. It’s basically, a global integrated order book, on which all assets can be traded, leveraging local market expertise. So, if a portfolio manager in Europe wants to execute a US security, we can leverage on our Boston trading desk. Every order can be executed in the place where you have the best capability and in the local time zone, leveraging on the full market day. We feel that that will give us an edge vis-à-vis our competition, because it will allow us to enhance the quality of execution, reduce dramatically the cost of trading and minimise the market impact over all, eventually adding value to the investment process.

I believe the choice an investment firm makes about its trading technology strategy can significantly  impact alpha generation. Having the right technology  infrastructure in today’s market place is a must to become a best-in-class asset managers and generate investment performance, beause the right systems will allow fund managers to focus on what they are paid for, without the distraction of having to spend time in navigating through cumbersome booking processes or downstream manual tasks. In today’s highly pressurized trading environment, you cannot ask to traders to execute a large amount of orders with the right quality, market timing and speed if they have also have to worry about filling the gap of poorly integrated systems, which eventually will translate in trade errors, opportunity costs and compliance breaches. The technology infrastructure that a financial firm adopts can have resounding repercussions both for the firm and potentially for its clients.

As an investment organizations that consistently pursue new asset classes, new strategies and new jurisdictions, in Pioneer senior management is greatly aware of the importance of having the right IT infrastructure in place to support growth and scale. 

Today in the bond markets, the traditional broker/ dealers have also become much less willing to hold large positions on their balance sheet. This results in large part from Basel III capital and liquidity rules even though these are not yet fully in place. The new capital rules require much more capital, perhaps four times as much as before, to be posted against trading book positions and the new liquidity rules disadvantage overnight repo financing which makes inventory holding more costly. In the US we also have Dodd-Frank and the Volcker Rule and in the EU, MiFID II, MiFIR and the FTT (which we consider in the final section) which give rise to further issues for market making

Agency trading aggregate liquidity, it does not add to it. You still need principal makers and those with the ability to warehouse risk in order to work your large positions while minimizing market impact

The intention of regulators is incentivising a transparent price formation process. This is good as long as transparency does not become an objective itself rather than a mean to achieve a better and fair execution for our clients. We are in favour of a greater transparency, of course. However, there are some orders that are just too big to be worked through an order book. These orders are subject to abuse by HFT and need either to be broken up in child orders or be allowed to rest in a dark pool. I think there is a lot more engagement from the industry this time to ensure that policy-makers get it right. In 2007 the industry was not ready and the unintended consequence of Mifid I have been quite dramatic in terms of fragmentation of liquidity

Liquidity is always the parameter to determine the success of a venue as well as the proper mix of participants. We expect each of the new proposed platform to prove whether they are really worth and can generate value for our trading processes.