rethinking the market

Transcription

1 : rethinking the market An ICMA and City Week partner event, May 11 th 2016 Andy Hill

2 What do we mean by liquidity? The ability to get a price in the size you require, when you need it? The ability to trade without major market impact? Can liquidity be measured? MiFID II/R liquidity measures Bloomberg s LQA Interactive Data s Liquidity Indicators What are the appropriate determinants? Bid-ask spread? Market depth? Expected time to execute? Market impact? Historical volume and prints? Characteristics of instrument? Distribution of holders? Should liquidity measures be based on trade data, or on what failed to trade? Is liquidity dynamic? Should liquidity have a cost? 32

3 Factors affecting bond market efficiency and liquidity Regulation Macro-economic conditions and monetary policy Spread compression and the search for yield Structural trends in the holders of bonds 33

4 The traditional fixed income liquidity model Provides for: Ready two-way pricing Immediacy of execution Client C Client J Client X Client B Client Y Client A Market Maker Client Z 34

5 The principal dealer (or market-maker) model Essential ingredients for the model: Availability of capital (balance sheet) to hold long and short-positions and warehouse risk Availability of an efficient and liquid derivatives market (such as single-name CDS) to hedge dealer positions Availability of an efficient and liquid repo market to fund dealer positions Skills and experience of the trader 55

6 The principal dealer (or market-maker) model Undermining the model: Availability of capital (balance sheet) to hold long and short-positions and warehouse risk Increased cost of capital (Basel III & IV) Volker Rule and restrictions on bank proprietary trading Availability of an efficient and liquid derivatives market (such as single-name CDS) to hedge dealer positions EMIR and other central-clearing or margining requirements for derivatives Availability of an efficient and liquid repo market to fund dealer positions Leverage Ratio, NSFR,... QE: negative rates and excess reserves Skills and experience of the trader Ongoing attrition of experienced staff and juniorization of trading desks 66

7 The evolving dealer model Principal trader Principal broker Agency broker Changes in dealer behaviour: Smaller inventories and faster turnover More considered allocation of balance sheet Deeper client engagement and awareness of needs More specialization and focus on competitive advantage More streamlined trading and sales desks What we lose is: Ready two-way pricing Immediacy of execution 37

8 Future potential challenges to bond market efficiency and liquidity MiFID II/R pre- and post-trade transparency requirements (for bonds and single name CDS) MiFID II/R best-execution requirements CSDR mandatory buy-ins Even higher capital and funding costs (FRTB, NSFR) Other miscellaneous regulatory challenges (e.g. MAR disclosure requirements) ECB s Corporate Sector Purchase Programme Ongoing macro-economic and geopolitical risks The unknown unkowns 38

9 How is the market responding? Electronification: new initiatives, platforms, tools, and protocols Changes in buy-side behaviour Use of alternative products, such as bond ETFs and CDS indices New, non-bank liquidity providers ( principal trading firms ) Discussions on changes in issuance practice ( benchmarking ) CMU Call for Evidence and the better regulation initiative 39

10 Electronification of the market Electronification has the potential to provide a wide range of efficiencies for trading: Pre-trade Price discovery and trade negotiation Execution Click to trade, smart order routing, algorithm based trading (potentially including the simultaneous execution of reference hedges) Post-trade Settlement and confirmation ( straight through processing ) Data capture and management Regulatory reporting, transaction cost analysis (TCA), cost expectation, counterparty evaluation, risk management, price discovery Ancillary services Trade analytics, liquidity scoring, portfolio analysis 310

11 Evolution of electronifcation in the corporate bond market Two key threads: Connectivity The ability to access ever more diverse and disparate sources of liquidity Data The ability to identify where those sources of liquidity are and to find the other side of the trade 311

12 Evolution of bond market e-trading protocols Early initiatives: Central limit order books (CLOBs) for inter-dealer market Disclosed request for quote (RFQ) systems for dealer-to-client market Streaming for dealer-to-client More recently: Opening up of RFQ to all-to-all, counter-pricing, and anonymous Standardized auctions ( liquidity windows ) Sweeps for matching odd-lots Anonymous matching for large blocks But dealer-to-client RFQ still dominates Today: Matching systems (or information networks ) Identifying sources of liquidity, and more axe driven rather than quote driven (more pointto-point than all-to-all ) 312

13 Changes in buy-side behaviour More reliance on primary market and less on secondary Longer-term views ( buy-to-hold ) Broadening as well as deepening dealer relationships Greater use of data (axe lists, trade history, etc.) to identify liquidity sources Utilizing other products, such as ETFs or CDS indices Utilizing e-solutions which offer new counterparty networks and trading protocols Greater use of internal crossing between funds Becoming price deciders rather than price takers Working harder than ever before 313

14 Conclusion: rethinking the market Do we have to accept that liquidity is a limited resource, that requires hard work to source, and comes at a cost? Will we move away from a liquidity model that is dependent on market-makers, or will we always be reliant on broker-dealers to some extent? Do we redesign the shape of the corporate debt markets to fit the established liquidity models of other markets (the equitization of the bond markets), or do we design new models and protocols that best fit the market? Can the corporate bond markets ever become fully exchange or platform based, or will they always require a basis of human interaction and relationships between participants that are built on experience, trust, and mutual understanding? Can the corporate bond markets continue to serve their economic function of bringing investors and capital raisers together, efficiently and effectively? 314

15 Bibliography Addressing Market Liquidity: A Broader Perspective on Today s Bond Markets, BlackRock, February 2016 Fixed income market liquidity, CGFS Papers, No 55, January 2016 Market liquidity resilient or fleeting? Global Financial Stability Report: Vulnerabilities, legacies and policy challenges: risks rotating to emerging markets, Chapter 2, October 2015 Global financial markets liquidity study, PWC, August 2015 Liquidity wars: Who wins and loses in the race to the bottom? Citi Research, June 2015 The Liquidity Conundrum: Shifting risks, what it means, Wholesale and Investment Banking Outlook Blue Paper, Oliver Wyman and Morgan Stanley, March 2015 The current state and future evolution of the European investment grade corporate bond secondary market: perspectives from the market, ICMA, November 2014 Market-making and proprietary trading: industry trends, drivers and policy implications, CGFS Papers, No 52, November 2014 The liquidity challenge: exploring and exploiting (il)liquidity, BlackRock, June 2014 Economic Importance of Corporate Bond markets, ICMA, March

16 About the SMPC The ICMA Secondary Market Practices Committee is an open forum for sell-side and buyside member firms active in the European investment grade corporate bond secondary market. Through open dialogue and engagement, as well as through its subsidiary working groups and work-streams, it seeks to be the representative body of the European corporate bond secondary market: addressing practical issues directly relevant to market practitioners; standardizing market best practice; disseminating relevant market information; and promoting the best interests of an efficient and liquid market. 316

17 About the author Andy Hill is a Senior Director in ICMA s Market Practice and Regulatory Policy group. For seventeen years he has been a repo and money-market trader, for ten years of which he was an Executive Director at Goldman Sachs. He has also worked as a consultant in the Aid and Development sector, primarily based in Cambodia, and previously served on the Board of the Cambodian NGO Education Partnership in Phnom Penh while under a Goldman Sachs Public Service Fellowship. He holds a BSc (Hons) in Business Studies from Cass Business School and an MSc in Poverty Reduction and Development Management from the University of Birmingham. andy.hill@icmagroup.org 317

18 This paper is provided for information purposes only and should not be relied upon as legal, financial, or other professional advice. While the information contained herein is taken from sources believed to be reliable, ICMA does not represent or warrant that it is accurate or complete and neither ICMA nor its employees shall have any liability arising from or relating to the use of this publication or its contents. International Capital Market Association (ICMA), Zurich, All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means without permission from ICMA. Contact: 318