James Rundle: Fixed Income’s Meteor Moment

Blink and you might have missed it. On October 15, 10-year US treasuries saw their own Flash Crash—or T-bill crash—moving from 220 bps to 182, before recovering to around 215. It’s a worrying sign in a market that’s hardly been outperforming its own historic values over the past few years, and although swap execution facilities (SEFs) were quick to point out that October 15 had record volumes, none of it inspires confidence.

It’s the icing on the cake over a furious period of interest in turning fixed-income trading electronic in nature. The benefits of this are clear to many, who cite increased transparency as well as lower costs, greater liquidity and a number of other factors which are touched upon in Marina Daras’ feature (see page 26). As electronic is inevitable, the sooner archaic asset classes such as fixed income embrace it, the better.

Not So Clear
The real picture isn’t so clear, though. With the advent of SEFs and the proliferation of electronic bond trading that had occurred for years before that, much of fixed income trades electronically already. Yes, shifting more onto these platforms may allow for more volume through advanced electronic methods of execution such as algorithmic trading, but it’s important to differentiate between volume and liquidity.

Secondly, there’s an element of resistance by the industry itself. Many fixed-income sales traders, particularly those who work for boutique brokerages, are employed on a commission rather than a salary basis, and the last few years have not been easy for them. Volatility is at an all-time low, and making commissions based on spreads has become harder than ever—indeed, some traders I have spoken to recently have not seen a proper pay check for a number of months now. Introducing fully electronic methods of execution may please the vendors and the flow monsters, but what about the individual sales trader on the ground? It might be their death knell, given electronic execution’s tendency to lower costs, trade sizes and ultimately, commissions.

Natural Evolution
The market is ultimately based on Darwinism, though, I hear you say. Surely these fixed-income dinosaurs have to adjust to the new normal of market conditions, just like the floor traders at the NYSE had to during the 1990s and the 2000s? Perhaps they do. Everyone’s job is changing thanks to electronic means now, from factory workers and check-out staff at Walmart through to business journalists and investment bankers. Nobody is immune. But there’s a loss of experience, knowledge and temperament that is potentially at risk with the blind march toward electronic markets, not to mention the risks of the medium itself. For instance, while SEFs appear to have weathered the T-bill crash well, their volumes aren’t what they once were, and there are lingering problems with rulebooks and other areas that have prevented significant sections of the market from engaging. Likewise, if this is what happens to instruments that already trade in a highly electronic manner, imagine what happens on a market that doesn’t have the kind of safeguards that an exchange does, yet trades broadly electronically. In terms of what the future holds, it’s algorithmic trading and periodic, mini flash-crashes, if it’s not thought out and constructed properly.

Going electronic for the sake of it is not the answer to all of life’s problems. Just ask the equity markets

But arguments on the pro side are hard to counter. Fixed income desperately needs a mechanism by which the larger buy-side firms can perhaps step into the roles vacated by the investment banks as market-making firms, and lowering the cost of business via  going electronic is the most obvious way to do that. Likewise, more transparency is sorely needed, and the regulators also desperately need more information about what goes on, assuming they figure out how to do anything with it. But while it is important to evolve, it’s also worth remembering that going electronic for the sake of it is not the answer to all of life’s problems. Just ask the equity markets.