The evolving regulatory regimes and mandates of Dodd-Frank, Volcker Rule, EMIR, MiFid II and Basel capital reforms are designed to increase transparency, reduce risk and drive OTC derivatives markets onto transparent and regulated markets and platforms.
As a result banks are radically changing, (and indeed cannibalizing) business models within the fixed income (FICC) businesses, pulling back or even withdrawing from more capital-intensive inventory based market-making activities in products such as credits as they move towards what is called a ‘capital light operating model’.
Banks are now specialising around core skills, value propositions and client franchise, with a reduction in those willing to be flow banks, whilst others specialise in execution capabilities around an agency model. As a result, clients will be offered execution services from banks that will be a blend of principal/agency, bilateral/cleared, all of which requiring investment by dealers in new technology and connectivity pipes to execution venues such as SEFs, post-trade reporting (TR) repositories, central clearing houses (CCPs) and more.
So, what’s happening in Europe in terms of fixed income e-trading, and in particular what’s the future for single-dealer platforms in fixed income?
Here at Caplin, we are seeing a number of regional banks – those with specialised niche capabilities such as liquidity provision in regional fixed income markets, or banks with agency execution expertise and smart order routing capabilities – look to extend their current FX SDPs to support delivering fixed income capabilities to clients. It seems that the regional banks may be stepping up in fixed income as the top-tier banks retreat (see market share analysis below).
Interestingly SmartTrade has recently announced the launch of a new Fixed Income solution designed to enable banks to service their clients electronically in fixed income, and according to David Vincent, CEO;
“smart-FI takes what is being done in FX and brings it to liquid fixed income products.”
Mckinsey have a great chart that shows the evolution of electronic trading, showing the products that are ‘e-traded’, and the success drivers.
Evolution of electronic trading (source McKinsey)
Looking at the products in the red rectangle, we see the more liquid and standardised products are suitable for electrification.
The table below (based on new research from Celent into European Fixed Income Market Sizing called Electronic Strikes Back), shows that in the dealer to client (D2C) segment for fixed income execution, multi-dealer platforms (MDPs) are by far the major electronic channel both in rates and credit products followed by retail platforms, with only limited flows going through single-dealer platforms.
Execution methods in Dealer to client (D2C) Fixed Income market in Europe 2014 (source Celent)
The above chart on execution methods in fixed income, is of course in sharp contrast to FX, where execution through SDPs and MDPs are almost equal. However, in fixed income, with banks pulling back in terms of liquidity provision, access to liquidity remains the biggest challenge for investors, and according to bench-marking research by Fixed Income Leaders, some 73% of investors cited sourcing liquidity as their biggest challenge, with some 48% of investors looking to try to resolve this in less liquid products by undertaking buy-side to buy-side trading using some of the new liquidity discovery platforms being launched (such as Algomi, Bondcube and others).
In terms of market share concentration, it seems just like in FX the top-tier banks still dominate Fixed Income, and according to Celent analysis the top five banks have 50% share in European fixed income trading. However, just like in FX the top banks are beginning to lose market share to regional Tier 2 & 3 banks. In 2014 the top five banks have lost 4% market share, whilst banks #6-12 have actually increased market share by 6%. This is partly due to some top-tier banks pulling back from some markets and partly due regional banks investing in new technology and stepping up to provide liquidity to clients.
–Tier I (top 5) market share down 4%
–Tier 2 (#6-12) market share up 6%
Market concentration in European Fixed income (source Celent)