Fabien Orève, Global Head of Trading at Dexia Asset Management examines the changing strategy of multi-asset trading.
OTC is today, in Europe, around 25% of equity trading, but if you look at bond trading, it is mainly bilateral.Trading fixed income depends on the willingness and ability of market maker or counterparty to make a market in particular instruments and commit capital. In equities today investors can interact with a much wider range of liquidity pools and market participants than in bonds.
However, I think much more importantly there is an ongoing slow process of convergence emerging amongst the different asset classes, and I believe this convergence is driven by two things. First is technology, second is regulation.
First of all is obviously the growing presence of electronic trading. Beyond equities, electronic trading is very important in foreign-exchange and now, in bonds.
Smart order routing and algorithmic trading in European equities have significantly increased since MiFID. Many investors now split their orders, and splitting an order has become the main way to trade intraday. Either you do it yourselves from your desk or you trade it with the partnership of a high-touch desk.
If you look at the derivatives side, we trade lots of listed futures at Dexia Asset Management and we are now thinking about putting all of the small size orders into algorithms. It’s basically another aspect that is automating.
If you look at the OTC markets, they have embraced technology as well. There has been massive growth in electronic enquiries to ECNs or multi-dealer trading platforms in fixed income products. We’ve seen that for the small to medium size orders over the last few years. Another thing is market makers. Many large banks we work with have improved their pricing technology, all of these dynamic pricing algos that tighten bid-offer spreads, but mostly for the liquid instruments.
For the liquid instruments, execution costs are low today. In core Eurozone sovereign bonds, we can execute at a very cheap level now because it’s highly competitive, and we are able to detect the basis points of cost.
I can make similar comments in foreign exchange for the G10 currencies. All of the algo trading now used by banks helps tighten spreads gives faster quotes and it is much easier than before to trade.
In addition to ECNs in foreign exchange, there are now algorithmic tools that are available for us. We are not using them yet, but we’re thinking about using algo tools for clients who would like us to trade new order types, like limit orders, which are quite new in FX.
Foreign exchange used to be seen primarily as a hedge. Now we’re seeing that some portfolio managers invested in bonds think about Forex strategies to get more exposure on trading ideas and to generate alpha for their portfolios.
The second area that is really driving the convergence, I believe, is the new capital and leverage rules. All of these new regulatory models that are coming mean that banks and our counterparties have less capacity to carry inventory. This is a significant issue in bonds, but it’s true for equities as well and may alter our capacity to trade on principal.
In equities we have recently traded fewer blocks of full size orders. That means we are more likely to fill partially an order with a block then work the rest in a market. In bonds, we’re seeing the emergence of equity-like solutions, such as multilateral trading facilities (MTFs) that could help us trade more instruments.
The point is with the new MTFs in the bond space, traders have a very low chance to get fills for the full size of an order at the desired price; and that’s a problem. But, looking broadly at this situation, we may consider a strategy where we could find a cross for a part of our order in an MTF, and then we can get the order balance executed or facilitated by a dealer. This is clearly something that gets closer to the way we trade equities.
Being on the right side of the banks
To continue on that theme, with the risk of not getting as much liquidity from banks that we are used to, especially in bonds, we have to stay high on the bank’s client list. As an asset manager, we have a responsibility to ensure that our relationship is very good. We have to concentrate volumes on fewer counterparties.
“Today it’s important that we have enough tier one counterparties in equities, bonds, listed futures and foreign exchange to help us build long term relationships with them.”
We also have to make sure that our tier one list of brokers is spread throughout the various asset classes. Today it’s important that we have enough tier one counterparties in equities, bonds, listed futures and foreign exchange to help us build long term relationships with them. This relationship aspect is only one thing though. As a firm we also have to adapt to the new paradigm. In this context, our portfolio managers and traders have reacted in different ways to the changing trading environment.
I’ve seen my PMs using more derivatives to hedge positions, especially in bonds, which is one way to react to some liquidity problems. We’ve seen some of our teams on the investment side focus on the liquidity of their portfolio, and as a result they try to select instruments that they know will not cause trouble if there is a sharp movement in the market.
I’ve seen other clients making their trades smaller. Also our PMs are trying to improve communication with traders, and this goes straight into their instruction.