Greater efficiencies drive bond trading revolution

Bond trading capabilities have come a long way, especially in term of speed and scale. This is primarily down to two factors: the way fixed income dealing has evolved - through technical advancement and the onset of automation - and how bonds have matured and evolved as an asset class.

Today, the global bond market is reportedly valued at more than $141trn¹ , and fixed income securities are being bought and sold every minute, especially as markets and the investment backdrop appear to be in a constant state of flux. Given that today we live in a world of ubiquitous trading of financial assets, gaining efficiency is vital. But certainly, efficiencies were not always there.

The early days

Rewind 30 years, and trading was a highly manual process. In some asset management firms, portfolio managers did their own trading, while in others, money managers gave handwritten bond tickets to traders to execute on their behalf. Traders would then scour Bloomberg screens for opportunities (often dubbed axes) and positioning information and then engage in lengthy telephone calls to negotiate trades.

When the best price was sourced and agreed, the deal’s details were entered into an execution system to record the trade. It is no wonder this process needed overhauling. It was clearly not suited to high turnover; the information gathering was too sporadic; required too much data entry and the overall manual interaction meant it was very vulnerable to error.

Rise of the machines

The solution to such trading desk inefficiency was automation. The more a process is automated, the more efficient it becomes; just like production lines in car manufacturing, bond trading needed to automate. But to achieve this, tools and production line efficiencies were urgently needed.

Automation came online with the introduction of order management systems (OMS), including programmes such as Simcorp, LatentZero Minerva, Charles River and more. These ran alongside portfolio management systems, which enabled fund managers to electronically create an order that instantly arrived in a trader’s ledger, known as a blotter. Provided a trade was solid from a compliance and risk perspective, it was executed.

This development allowed traders to easily group orders together by bond type, asset class and by currency. It also meant they could see company-wide trading orders.

All trading activity was centralised – orders were sent to the appropriate execution desk; credit trades went to the credit traders, emerging markets to emerging market traders and so on. It massively cut down the time to market and increased trading desk efficiency.

In the beginning, deals were predominantly executed by phone; details were recorded with competing quotes and allocated fairly and effectively and then posted, so that middle and back offices could then settle and match with the counterparties to the trades.

Further enhancements

These systems continued to develop and soon started being further enriched with data, helping traders make more informed decisions. Running alongside an OMS could be an execution management system (EMS) with axe data (that is, who is bidding, or axed, to buy or sell a particular bond) as well as the last traded levels and pricing sources. We developed our own in-house EMS enriched with all the data we needed to be more efficient, including all internal and external trades as well as live prices.

Once we had this central point to collate our orders, we then needed to look at how we traded them. Fixed income trading broadly falls into two groups: low touch orders which are smaller sized tickets in more liquid bonds such as government debt and investment grade bonds; and high touch deals, which normally involve larger trades and in more illiquid assets such as emerging market debt and high yield.

For lower touch bonds a solution was needed, and this came in the form of electronic communication networks (ECN) and the genesis of electronic trading where Fix connectivity traders (a communications tool for international real-time trading) could release a fixed income trade to an ECN there and then. They could open an enquiry to multiple counterparties and within a three-minute window execute at the best of a multitude of prices, a process which would have taken considerably longer by phone.

This rapidly gained popularity, and an ever-greater number of low touch orders were traded electronically. It evolved very quickly - from a single request for quote, to sending lists of bonds for pricing and finally entire portfolios of bonds in a portfolio trade. 

The next era

The growth of electronic trading gave buyside trading desks scale, efficiency, global reach, and straight-through processing. Today even one-to-one negotiated trades are confirmed through these electronic platforms and with ever more alternative liquidity providers joining the platforms the reach is truly global.

The digital age ushered in new data sources. We have information at our fingertips where we can   see the best potential outcome of a trade. All this trading data has given us better benchmarking and we have seen amazing developments in data analysis and transaction cost analysis (the true cost saving of trading). Electronic trading is very much hardwired into the modern trading desk model.

Recent trading innovations, combined with experienced traders who manage relationships and drive through pricing efficiency for clients, have brought in a wave of advantages. But development never stands still and there is always something to focus on as every efficiency can be better for processes and clients.

The trading desks of 30 years ago, with limited data as well as manual systems and laborious processes, has given way to automated, efficient trading desks. The hybrid between automation and experienced traders negotiating large trades drives cost savings for investors but the future still has much to give us.

Technology has provided an ever-expanding bag of tools to deploy as necessary but what does this mean apart from allowing more scalability and efficiencies? It gives us cost savings - which is at the heart of what has driven our investment in traders and trading systems.

Artificial intelligence (AI) will most likely drive the next wave of development, and it will further help cut time to market and increase the certainty of best execution. For example, it could potentially assist in the management of low-turnover portfolios, such as buy and maintain strategies. AI could help in terms of security selection, duration and credit quality based on desired parameters. If AI predicts cash flows and bond maturities, orders could be sent straight to trading desks with minimal portfolio manager intervention, freeing them up to focus on investment strategy. But AI is still in its infancy, in trading terms at least, but history has shown us the speed at which technology can advance.

Ultimately, markets will continue to evolve and the way we trade them needs to move forward too. We need to be agile and curious, and most vitally, be aware that while technology is absolutely a boon to the industry, individual experience – and knowing how and when to use this technology – is what truly counts.