Fixed income traders have long been shy of transparency around pricing and execution. Comparing them to the “last uncontacted tribes in the Amazon” one commentator recently suggested that for some participants, trading and valuations are based on “superstition, intuition and guess work” instead of high quality data. It may not be a caricature that FOW readers recognise – but most would acknowledge a grain of truth. The world’s regulators are fully intent on entering this jungle and imposing a new rulebook, whether that’s Mifid II (and III) or the Fundamental Review of the Trading Book (FRTB).
Their aim, of course, is to restructure fixed-income markets by mandating full price discovery and formation across the market. To accomplish this, regulators want to promote greater transparency, transition the market from indicative to firm quotes and mandate fair access to firm quotes for all participants.
The move comes as some unstructured fixed income markets like corporate bonds have seen staggering growth in recent years, buoyed by unconventional monetary policy. This increase in market size has been accompanied with an expansion in market breadth, bringing in an unprecedented amount of ambiguity when valuing and trading bonds in what is still an illiquid market, compared to equities.
Such regulatory incursions haven’t been welcomed by all. There is no shortage of those arguing the existing market making model is already under stress due to economic conditions – and that if transaction costs rise and client bases are restricted by market makers in an attempt to avoid risk, this will hurt trading activity and ultimately overall market liquidity. For better or for worse, this argument hasn’t been won.
And for those anticipating regulatory pressures to unwind in the City post-Brexit, the writing looks to be on the wall. Globally, Strategic Trade Authorization in the US, the Financial Conduct Authority in the UK, Hong Kong Securities Finance Commission, Monetary Authority of Singapore, Australian Securities & Investments Commission in Australia and the Prudential Regulation Authority have committed to continue their journey. From Mifid II, the latter requirements of European Market Infrastructure Regulation (Emir) and Central Securities Depositories Regulation (CSDR), compliance pressures, are going to continue, irrespective of Brexit outcomes.
Market actors, as a result, need to rethink their system landscapes. With FRTB for example taking an increasingly stringent line on what you put in the trading book and what you put in the banking book, front offices need to be much more integrated with risk departments. Banks need to show their risk and front office models are comparable at the desk level. This must be achieved without impacting the flexibility and responsiveness of the risk infrastructure whilst at the same time assuring the second line of defence role of the risk department.
With FRTB having been postponed, many players are trying to buy time. Mifid II, however, is less than eight months away and many firms still don’t have the same valuation methods in place across their systems. They are running a considerable risk and are also missing out on a real opportunity. It’s not just price transparency that is driving a need for modernisation of legacy infrastructure, it is also the rising need to collect and collate growing reams of data. Under Mifid II, for example, asset managers have to provide clients with portfolio statements quarterly instead of biannually. This coupled with enhanced compliance procedures means more detailed record keeping requirements will also be introduced.
The challenge, in short – irrespective of Brexit – is to continue to create efficiencies for business systems and processes in the face of the regulatory or political ground shifting; broader macroeconomic and technological pressures are not going to go anywhere, for the fixed income market or anyone else. This represents an opportunity to grow.
Many such technologies emerge from the UK – which at FIS we see as continuing to embrace its position as a hub for fintech development. It was great to see the data released ahead of London Tech Week in June: the total amount invested across the tech sector since the EU referendum has now passed the £1 billion mark – with investment in Q1 of 2017 at its highest since the Q2 of 2015.
The need for traders, brokers and asset managers to trade and manage positions and risk in the global capital markets – in what is a rapidly transforming trading industry – is growing. Flexible technology platforms to manage both listed and OTC traded instruments across the entire trade life cycle are vital; from order management, trade execution, market making, and position and risk management to clearing and settlement. What is also increasingly crucial is that they integrate instruments on one trading platform, helping to reduce total cost of ownership – and compliance risk – through system consolidation that facilitates total real time transparency. Like your bit of jungle? Investing in it beats losing it.