FICC Market Structure: The Electronic Trading Evolution

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Kate Finlayson: Hi, I'm Kate Finlayson. I head up the FICC market structure team at J.P. Morgan. We follow trends and drivers of market structure change. Along with various policy initiatives, one of the largest drivers of change is the electronification of markets. I'd like to take a fresh look at this topic to understand where we're at in fixed-income markets. What automation themes we're seeing, and what could drive more electronic trading. To do this, I'm delighted to share the mic with Chi Nzelu, Global Head of FICC e-trading, and Andreas Koukorinis, Global Head of credit e-trading. Welcome to you both.

Chi Nzelu: Thanks, Kate.

Andreas Koukorinis: Great to be here.

Kate: So, today, I'd like to delve deeper into the detail of electronic trading, what trends we see emerging or advancing in different markets. Before we get into that, the term electronic is often used in different ways when it comes to trading so perhaps, we can frame how we regard it. For example, if a voice trade is consummated on a venue that could, according to certain metrics, be deemed an electronic trade. The bank of international settlements considers electronic trading to include electronic quote “requests," the quotation of prices or dissemination of trade requests electronically, and the matching negotiation or execution of trades through an electronic system. Do we see it that way?

Chi: So we have very similar definitions, but we see it more of a spectrum. We can think about all electronic markets or platforms starting with a voice trader triggering a price and depending on the evolution of market structure, we can get market data develop a systematic process to distribute prices, accept trades, and then systematic risk management. Across the different asset classes, we have some fully automated price accepts risk manage, and we have somewhere in the middle hybrid.

Andreas: Yeah, I think, uh, Chi is right on point. So, there is electronic transmission of trades which allows us and helps us to capture the data. And then there is algorithmic trading, which is based on building pricing and risk management frameworks on top of that data that will capture electronically and, ultimately, that leads to, you know, for lack of a better expression, no-touch trading where the request gets transmitted electronically and then both the price and the risk management happened algorithmically and, therefore, electronically.  

Kate: Okay, that's helpful, thanks. So, with that in mind, we know that markets continue to evolve and we've seen some interesting themes emerge in electronic trading across fixed-income currencies and commodities. Andreas, what trends would you particularly highlight either because it's new development or has perhaps accelerated?

Andreas: So, in my mind, two things come up. One is execution protocols are based on streaming prices. So rather than have tentative prices or just responses to RFQs, the market has evolved where we are basically streaming two-way prices firmly on a variety of instruments. And then clients either click to trade or respond with their interest on the back of that price. That helps on two fronts. One is obviously allowing people to price discover in a more efficient manner, and second, our ability to internalize is so much greater, therefore, we can give better pricing. The second element, which is parametric trading, which is a protocol that has evolved on the back of protocols that have been prevalent in the muni-market in the US, is where clients submit their requests, not on a specific icing i-Security, but more using parameters on a basket of security. So, it could be rating, duration, spread levels, and so forth.

Kate: So, the increase in systematic funds in credit markets is having an impact in the trading protocols utilized by market participants. Is that right?

Andreas: Yeah. So, I would say there’s two things. First is obviously as the market gets more electronified, there's a prevalence of a number of platforms. The protocols become more standardized, availability of data, and so on so forth. Funds start emerging that have the capabilities of using that toolkit to participate in the market, but also existing funds that come predominantly from the equity or the FX markets are deploying their toolkit in the credit and possibly in the broader securities market and allows them to both be a liquidity provider, but also liquidity taker, which makes the market more complete. From our vantage point, that percentage was in the single digits, you know, in the last 18 months, and we expect it to be close to 20% to 30% in the next 5 to 6 years.

Kate: What else do you think could be driving these trends?

Andreas: I think really is the availability of data really is the biggest driver, and the second is the evolution of EMS and OMSs. And..yeah - that would be it.

Chi: So, we think a huge part of this is client expectation. So, a client who has traded US treasuries or European government bonds or foreign exchange or commodities may have unexpected format of the market. They may expect a two-way price with the inventory always available on a very competitive order book. As a result, that expectation goes back to the liquidity providers who now have to develop these capabilities for areas like credit.

Kate: One of the protocols that's gained a lot of attention in recent times has been portfolio trading. What are your observations there?

Andreas: Look, portfolio trading is really the protocol for immediacy, right? So, it really allows clients who want to do a large block transaction, whether it's in a concentrated basket or a well-diversified basket, to execute immediately and get the position they want on, rather than taking the market risk. It's not dissimilar to program trading from equities. I think what's been happening is obviously that is becoming a bigger and bigger proportion of the markets and that correlates well also with the increase in ETFs, and that gives us a lot of ability to improve our pricing engines. And I think more importantly because those baskets tend to have by construction some instruments that are less liquid, they are allowing the price discovery process for instruments that historically would not be trading as much to start finding traction in the market.

Kate: Chi, when it comes to algorithmic execution, spot FX is often in the frame and the use of algos continues to advance. What other asset classes are showing signs of adopting this form of execution?

Chi: Sure, just to start with, we think the use of algos in FX has also evolved. It's now driven by analytics. People are interested in understanding volume profile, market impact, feedback loops, specific to the proliferation across other asset classes. We think it's really driven by clients expecting similar functionality and we see that in areas like US treasuries, commodities, in particular, index products where you may have to execute 30 underlines and wrap that into one. As a result, the entry point into the different asset classes seems to be at a significantly higher level to what was done in foreign exchange with the expectation of clients around mentioned issues like volume profile and market impact. We see this continuing potentially into the areas like European government bonds and we're investing in those areas.

Kate: Andreas, you mentioned very briefly ETFs a little earlier. What are your observations there?

Andreas: The ETF market is evidently growing massively both in fixed income and in other instruments. We're close to 1,100, 1,200 ETFs trade globally then cover close to 90%, 95% of fixed income securities. In my mind, it's the perfect vehicle that allows both for risk management but also for the fungibility of security instruments into cash. So with the primary process, it really helps complete the triangle between single bond algorithm trading, portfolio trading, and ETFs, as it allows us to convert one instrument into the other by using sort of both the three legs of that transaction.

Kate: Interesting. Thanks. With these evolving protocols, the fact that there is this demand for firm streaming liquidity, for low-touch portfolio trading, what are the knock on impacts in terms of market infrastructure?

Andreas: I think the prevalent is the increased need for direct API. Both venues and platforms are going to be under pressure to modernize and bring better and faster protocols into the markets. Portfolio trading is a sort of pre-eminent one where things still have a manual component to it. I think as we evolve, there will need to be end-to-end connectivity. And the second is obviously we would prefer the direct connectivity to our clients and allows us to show better pricing and more liquidity as we can internalize easier with less information leakage.

Chi: I think there's also a knock-on effect for liquidity providers. There will be required investments for those who perhaps are unable to offer from streaming to develop those capabilities, as well as the combination of things that were separate like access and price discovery, we see those two things coming together, which leads to strong connectivity of inventory in-house and price distribution on electronic channels. So we expect that to drive more efficiencies.

Kate: Okay, so looking ahead to the future of electronic trading, the developments of your teams and how they look to enhance their skill sets. What work is being done to prepare the trading desk of the future from a sell-side perspective?

Andreas: Sure. So, a few things. Organizationally, we work very, very closely together. Traditionally, the trading desks have been product experts. The Strat teams have been engineering science experts. More recently we've been investing in training programs on data and analytics. We have over a thousand of our trading and sales colleagues that have taken that. We think that significantly advances the type of discussions we have around trading strategies and market evolution.

Chi: Yeah, I would say specifically for our teams is there's definitely a shift from just having the Strat function, connectivity and engineering to really trying to understand the risk management process and deploying systematic strategies at scale in the market. And really fine-tuning how we sort of accumulate and extinguish our inventory.

Kate: Okay. Well, I mean, this continues to be an evolving space. So many developments. Thank you so much for your insights today, Chi and Andreas.

Andreas: Thanks very much, Kate.

Chi: Thanks for having us.

Kate: And to our listeners, stay tuned for more episodes. Thanks for listening.

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