MTS: 25 years of expertise
"As much as 95 per cent of the most actively traded government bonds could be traded electronically in the relatively near future"
Bond trading is evolving rapidly and fixed-income trading venue MTS is at the forefront of change. John Beck reports.
The electronification of bond trading is well under way. Having gathered real momentum in recent years, the process is expected to gain ground still further as pressures mount on market participants and they become more comfortable with the concept.
Few are better placed to observe these changes than fixed-income trading venue MTS. Majority-owned by London Stock Exchange Group (LSEG), MTS celebrated 25 years of operations in September 2013 and its CEO Jack Jeffery, expects the ratio of voice to electronic trades of government bonds to change dramatically over the next few years.
“During 2013, the ratio was around 70:30, but we think that over the next two or three years we will see a complete reversal of that ratio. In fact, as much as 95 per cent of the most actively traded government bonds could be traded electronically in the relatively near future,” he says.
For market participants, one of the primary attractions of electronic trading is cost efficiency. Transaction costs can be reduced significantly, more than four-fold for some products, according to a study entitled ‘Click or Call? Auction versus Search in the Over-the-Counter Market’ by the University of California’s Haas School of Business and BlackRock. For sell-side firms, of which there are fewer major players in the market than there once were, it provides a way to streamline operations while at the same time maintaining a wider distribution to market participants.
More transparency, lower costs
The underlying force, however, is a rapidly changing regulatory environment. Capital requirements are increasing and the industry-wide drive for transparency is pushing secondary bond markets towards an automated, venue-driven model. The European Parliament is nearing completion of a revised version of the Markets in Financial Instruments Directive (MiFID) designed to strengthen and stabilise the European financial sector. While some have proposed exempting both credit and derivative products from stricter transparency requirements, European Union financial services’ regulator, Michel Barnier, has pushed for bond trading to move to open electronic platforms.
Buy-side firms, meanwhile, are facing increased audit and regulatory demands. “Compliance, audit and regulation play a big part in the reason that people move to electronic platforms. We probably spend at least half of our time as senior management focusing on regulatory issues and making sure that we’re comfortable with them in terms of the business. It’s a different world from how things were five years ago. I think that’s here to stay and if anything, will become, even more so, something that we need to cope with,” says Jeffery.
For customers, there is very little in the way of apparent downside to this move. As well as lower pricing, a more transparent marketplace should allow them to be more accurate about decisions they are making.
“I think that’s going to be a key thing for customers: having confidence about where they have traded, where they have hedged, and about the liquidity around exiting those positions,” says Jeffery.
There is also a newfound collaborative push amongst both buy-side and sell-side firms to boost credit market transparency and efficiency in a manner which has not always been the case before.
“I don’t think we’ve ever seen the buy-side and sell-side being so accepting of sitting round the table and trying to resolve the model as they are right now. I think that over the next two to three years, this will play out and be a significant benefit to customers and all of the rest of us,” explains Jeffery.
In this changing environment, however, banks may have to rethink their role, just as they did when equity markets went electronic. “It doesn’t mean there won’t be a role for banks, there will be, I just think it will be a different one,” says Jeffrey. “The sell-side understands that this is something they’re not going to be able to stand in the way of, and they need to find the right model for them.”
A new look
Sweeping changes look set to continue and many believe that, over the next two decades, markets for government and corporate bonds will start to look much more like the equities world of today: with wholesale and retail activity merged and all products cleared.
“It could even be that the push towards clearing and settlement means that every financial product will be cleared within a decade,” says Jeffery.
“I do think we will move to a much broader, regulated exchange-type environment, but not with one venue dominating. I expect there to be a number of participants who provide those services and that they will be aggregated by both buy-side and sell-side, providing one pool of liquidity for each of those customers,” he adds.
In the meantime, MTS will not be standing still. Recent initiatives include MTS Prime, a broker-neutral market model allowing institutional investors to trade directly on its MTS Credit and MTS Swaps order book via a sponsorship arrangement. In partnership with broker and clearer Newedge, MTS also launched ACM (Agency Cash Management), an electronic auction-trading platform, which allows investors to enter into secured money market investments by means of the tri-party repo mechanism.
MTS has announced plans to move into the US too, with a new platform for institutional investors. This will allow participants to access real-time pricing from the major European dealers via MTS’s BondVision platform and execute European and US government, agency, mortgage and corporate bonds. Pre-launch issues are being addressed and future plans include an interest rate swaps product to be launched in 2014.
The move is entirely logical. The sheer size of the US market makes it an attractive destination and MTS was keen to set up shop there itself rather than entering into a partnership. It is also a marketplace in the throes of dramatic change. According to predictions from consultancy Booz & Co, up to 45 per cent of the US corporate bond market will be traded on electronic venues within a two to five-year timespan.
“In terms of our strategy, the US was really absent. We have quite a lot to offer in terms of European government bond liquidity and expertise and the US treasury market is mainly focused on two or three main vendors, so there’s room for a competitor in such a large marketplace and its one in which we wish to compete,” explains Jeffery.
Venturing stateside is just the latest step in a process of evolution and expansion for MTS.
“Markets are changing and we are too. This process will continue over the next 25 years and beyond,” says Jeffery.