Buyside firms sitting on trillions of dollars worth of fixed income assets are taking the first steps towards a more active role as liquidity providers after Basel III capital and leverage rules forced banks to pull back from traditional market-making roles.
MarketAxess has seen more than 420 buyside clients provide liquidity on its all-to-all public order book, Open Trading, which combines inventory from almost 100 dealers with client axes.
“Dealers are still the main source of liquidity, but we’re beginning to see a behavioural shift and have seen real growth in buyside firms becoming price makers as well as price takers,” said Gareth Coltman, head of European product management at MarketAxess.
Open Trading saw a record US$37bn of trades globally, during the first quarter, representing 12% of trading volumes across the entire platform. Buyside firms accounted for more than half of that liquidity with 48% coming from traditional long-only funds while 22% came from other providers such as hedge funds and ETF-authorised participants, which are responsible for creation and redemption of the listed funds.
“The likely trend is that we’ll see more electronic trading and we expect to see Open Trading grow as an overall percentage of those volumes as it pulls together disparate pools of liquidity that couldn’t previously connect,” said Coltman.
It is not just the incumbent providers that are gaining traction. Liquidnet, which launched its buyside fixed income dark pool in September 2015, racked up more than US$2.2bn of trades during its first seven months of operation, with almost US$1bn traded since mid-March. The firm now has 130 US clients and 50 in Europe.
“As we’ve onboarded clients, we’ve really seen numbers start to grow and with another 40 European clients lining up to join the platform, we see no reason why we can’t more than double those trading volumes this year.” said Helen Burgess, fixed income sales director at Liquidnet.
She notes that activity has ranged from the most actively traded bonds to illiquid instruments where clients would have struggled to find a match outside of the platform.
The role of the buyside as liquidity providers has long been debated as they typically take the same directional view and traditionally had little appetite for activities that fall outside their fiduciary duties.
“Buyside traders are starting to get used to being liquidity providers,” said Mark Taylor, fixed income sales director at Liquidnet. “It’s becoming more common to see former bank traders move to asset management desks. They’re much more comfortable with market-making so we’re seeing a real change in behaviour.”
Growing evidence of the cost savings that can be achieved on electronic platforms may also be helping to align buyside liquidity provision with Finra best execution requirements.
“Buyside firms have a responsibility to achieve best execution and in situations where you can’t find liquidity or where you can demonstrate lower cost execution by posting liquidity in Open Trading, there’s a strong argument that making prices is part of that obligation,” said Coltman.
He notes that average cost savings per trade in developed market products on Open Trading are around 20 cents above the nearest dealer cover. With average European investment-grade bid/offer spreads around 40bp, liquidity providers are trading closer to the mid-price.
Liquidnet notes that 65% of trades on the platform are made within the spread.
In the US, buyside firms have greater pricing visibility due to the high level of transparency as fixed income trades are reported in Trace. In Europe, third-party pricing data is underpinning growth, though pre- and post-trade transparency is required for the most liquid products under MiFID II, which is set to go live in January 2018.
Liquidnet, which has seen almost half of trades come from European clients, has partnered with Interactive Data and Markit to create a daily feed of reference pricing, and also makes prices of trades on the platform available to all clients, though trade sizes are not disclosed.
MarketAxess launched Axess All in 2015, using Trax data to summarise intra-day pricing for the most liquid bonds with the last traded price and highs and lows for the day. According to Coltman, the service provides information on approximately 65% of all fixed income transactions in Europe.
That has supported activity on the European arm of Open Trading that launched in 2015. European credit products traded US$944m on the platform during the first quarter, while US$4.8bn was traded by European clients across European and US credit products, up 73% from the fourth quarter, reflecting attempts by European clients to tap liquidity from the regional US dealer network.
