New protocols could offer big gains amid intensifying competition
The continued evolution of electronic trading holds big promise for fixed income asset managers. Innovations which automate small trades can now liberate resources for large, higher value transactions - and as industry margins shrink, the need for efficiency has never been greater.
On the sell side, the horse has left the barn: major banks including Citigroup, JP Morgan, Goldman Sachs, Morgan Stanley and Credit Suisse already rely on algorithms to assess and execute small or so-called ‘odd lot’ trades.
For banks, the transition has been driven by structural shifts post-credit crisis - tighter regulation, investor demand and strong corporate bond issuance - which meant clear incentive to implement automation for odd lots. Now, the buy side is experiencing its own structural pressures, as scrutiny on performance sharpens focus on resource allocation.
Fixed income has long been regarded as an opaque asset class that was time-intensive to transact - a dynamic that still holds true for large trades. Yet the ability to automate odd lots in corporate and municipal bonds, shows that new data - and the technology to distill it - can boost asset class liquidity.
For corporate bond activity, odd lots of $1 million or less account for 92% of transactions but only 22% of overall notional traded
For corporate bond activity, odd lots of $1 million or less accounted for 92% of transactions but only 22% of overall notional traded.
For small transactions, a trader seeking liquidity would historically put a Request for Quote (RFQ) out to market. They would wait for responses, and evaluate these based on arbitrary criteria before executing: a specific number of quotes, an ‘acceptable’ price level, or a certain counterparty to respond. It was, and remains, a time-intensive process for odd lot trading.
The buy side has taken initial efficiency steps, by utilizing technology to automate the evaluation process of RFQ responses. The next logical step for advancing efficiency is the adoption of Click to Trade.
Click to Trade (CtT) functionality is significant, because it offers the opportunity to automate the entire trade cycle for odd lots. A buy side trader can access additional pre-trade transparency with access to CtT liquidity pools, evaluate potential orders against executable pricing, utilize a rules engine to validate orders, and have orders quickly executed with straight through processing.
This represents a huge leap in efficiency. By automating the bulk of lesser value transactions, a trader can focus on more valuable trades. On the buy side - where automation has mainly centered on RFQ - it presents clear opportunity for additional efficiency gains.
More broadly, the adaption of protocols for specific uses continues. As RFQ moves to the domain for large trades, Click to Trade looks set to become integral to Best Execution and operational process improvement for odd lot activity.
For the buy side, its application to odd lots promises efficiency on several fronts: more time for high-value trades, utilizing data earlier in the trade cycle for better decisions, and additional resources for idea generation as industry competition intensifies.