The DESK looks at best practice for longer term liquidity support.
Buy-side traders see that sell-side fixed income dealing desks who both make money for their banks and happily provide liquidity, often have three elements in common; they have balance sheet, they have volatility appetite when looking at their P&L, and they are often broad sales desks, who can cover a range of clients.
Yet banks are under considerable pressure on multiple fronts, which makes these characteristics increasingly scarce. Firstly, competition in the bond markets from non-bank liquidity providers is delivering very tight bid-ask spreads in parts of the market, notably indexed bonds. Secondly, capital rules are reducing the capacity of banks to provide balance sheet, as holding riskier assets such as corporate bonds requires greater capital to be held as a risk buffer, which cannot then be used elsewhere. Thirdly, cost pressures are driving dealers to automate processes wherever possible, and that has reduced the budget for long-serving high-touch traders.
“On the sell side, spreads are compressing so firms are finding it hard to make money from flow business, across asset classes, and at the same time, prudential rules are impacting risk taking, so it’s a very difficult environment at present,” observes Ed Wicks, global head of trading at LGIM.
All of this creates challenges for buy-side firms. A sell-side desk with discretion over P&L can occasionally take a hit to support liquidity flow in volatile markets, because over the longer term the desk will make back money. If those desks reduce it can be harder for buy-side traders to find the other side of the trade in fast markets.
“Comfort around moving the size of risk can often be sell-side trader dependent,” notes one buy-side trader. “If you’ve got big sizes, it’s often a specific trader who you reach out to, regardless of the bank, because they’re comfortable with risk.”
The electronification of markets and weakening of relationships can gradually unwind the motivation of banks to deliver liquidity, especially if trading is entirely commoditised.
“As request for quote (RFQ) has expanded from going to two or three dealers, now it can be six plus,” says Audrey Blater, senior analyst in the Market Structure and Technology team at Coalition Greenwich. “That buy-side desk may not care who executes it, because everybody’s going to give them a price. This comprises margins.”
In parts of fixed income that are only partially electronic – and that includes the global corporate bond market – many buy-side desks would like to see an optimal mix of sustainable trading and efficient pricing.
“Traditional over the counter (OTC) trading has historically been done by dealers distributing market data over email,” says Jason Quinn, chief product officer of Trumid. “That inquiry tends to come in non-comp. This way of trading is important from a high touch perspective, because it tends to be higher quality. There is a desire from both sides not to have the market gravitate towards 100% competition at all times.”
Read the full article on fi-desk.com