Fixed Income's Dead? Long Live Its Technology

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SEC Commissioner Mary Jo White hinted last Friday that fixed income might be the next technology rabbit hole the Commission jumps down. That seems like good news for the buy side—but is it?

It's a common refrain, usually made in unsubtle declarations every few years: Fixed income's dead, rate volatility is soon coming back, and everyone in the space should be polishing their CV. Anecdotally, a handful sell-side sources have confirmed as much, with some broker-dealers either already thinning their teams down, or at least pondering that possibility.

Yet, as the CEO of a boutique fixed-income specialist that is actually growing its staff pointed out to me this week, no one who wants to be successful in this fickle asset class gets into it only to grow impatient; in fact, an appreciation of cyclicality is right there, implied in the name. And recent, heightened attention from another interested party would seem to reaffirm its relevance, as well.

That party, of course, is Securities and Exchange Commission (SEC) chair Mary Jo White.

Speaking at the Economic Club of New York on June 20, White continued to hone in on technology and its role in the US securities markets, though she seemed to take everyone a little by surprise when, in the final section of her remarks, she turned to fixed income, with a special focus on the role of "intermediaries.”

As the Commissioner said,

At some points in White’s thoughts, "intermediary" and "traditional dealer" seem to conflate, and of course, there's good reason for that. But it also skirts reality a little bit, in that across much of fixed income—especially corporate bonds—today's inventory no longer sits with the banks, but rather with large buy-side firms.

... In contrast to the equity markets where the concern perhaps is whether technology and competition have taken us too far, one might instead ask for the fixed-income markets whether the transformative power of these forces has been allowed to operate to the extent it should to benefit investors.

It is striking that the dramatic technological advances that have transformed the equity markets over the past decade have had only a modest impact on the trading of fixed-income securities. While today there are a number of electronic systems that facilitate trading in fixed income securities, they tend to be “inventory-based,” providing information primarily on the bonds their participating dealers would like to sell. In addition, information about the trading interest reflected on these systems often is restricted to participating dealers and select customers. So, although new technologies are gradually being incorporated into the trading of fixed-income securities, producing efficiencies and some pre-trade pricing information, it appears they are being used primarily to support the traditional dealer model.

The rest is worth a read, and from a buy-side perspective I took away two things, both serving to highlight the complexity of—pardon the pun—fixing fixed income.

The first goes back to the CEO at the boutique dealer, who also manages some separate money in-house, and therefore sees both sides of the market.

When I brought up White's thoughts, he immediately agreed that greater transparency into pre-trade pricing would help shops of his size, as well as retail investors. But in the very next breath, he also pointed out that electronic trading would never fully catch on—especially for high-yield and more illiquid opportunities. That bifurcation will remain, and because it does, an optimal and efficient price for everyone will always be difficult to secure.

The second takeaway goes back to just who the intermediaries in this space actually are. At some points in White’s thoughts, "intermediary" and "traditional dealer" seem to conflate, and of course, there's good reason for that. But it also skirts reality a little bit, in that across much of fixed income—especially corporate bonds—today's inventory no longer sits with the banks, but rather with large buy-side firms.

They have a larger stake in these markets than ever, and as recently seen with new steps taken in the BlackRock–Tradeweb technology relationship, they're looking after it very seriously, with ever-greater types of fixed income, like active treasuries, going electronic.

Then, again—and just like the sell side in the past—rational self-interest incentivizes these same firms to prefer control and stability in the markets to which they're now greatly exposed, possibly at the cost of White's hope for more pre-trade openness.

Those two things are in no way mutually exclusive, but as a practical matter, they often tend to get in the way of each other. It should be fascinating to see what else the SEC comes up with, and indeed, if the industry can get there first.

 

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