In the same way we all have had to adapt to the ‘new normal’ way of working, fixed income markets regulation also needs to adapt to key trends that Covid lifted the veil on. The buy-side wants more diversity, has become much more automated, and is now trading significantly more with electronic liquidity providers (ELPs). All of these things point towards a significant shift in the way these markets are functioning, and regulation should recognise and reflect this shift.  

We are on the brink of fundamental realignment of how European capital markets operate, a shift caused by a changing dynamic between buy and sell-side participants. When the pandemic hit last year and physical trading floors had to close, many buy-side participants experienced the drying up of conventional sources of liquidity – especially in fixed income. This resulted in the buy-side having to widen the net beyond traditional sell-side relationships and look beyond for additional sources of liquidity, leading them to the doors of independent market makers: ELPs.

Much like video conferencing, which had been in existence for some years but was not ubiquitous pre-COVID, ELP fixed income liquidity provision had been around for quite a while already, but the buy-side experienced its full potential only when circumstances fundamentally changed. When they did, they discovered that ELPs are an incredibly valuable source for liquidity. The ability of ELPs to warehouse risk across a wide and more diverse pool of assets has increased the inventory that buy-side participants can engage with and is enabling buy-side dealing desks to change from being the passive recipients of sell-side liquidity to becoming more assertive participants in sourcing and building latent liquidity from a variety of sources. Hence, market makers and the liquidity they provide in fixed income products offer a valuable new window into a new, re-shaped execution landscape which is more diverse, more efficient, and more resilient.

In our two latest research reports, we interviewed global heads of trading at 30 EU and UK based asset management firms with over $35 trillion of assets under management. The main finding of the reports is that the buy-side are looking to further diversify their liquidity partnerships. For many buy-side firms, Covid-19 was the wake-up call that they needed to review their liquidity relationships on a more permanent basis going forward.

Another key finding of the reports is that the electronification of markets post-MiFID II enabled buy-side firms to better navigate the liquidity challenges during the pandemic compared to the 2008 crisis. However, their ability to source additional liquidity electronically (including from non-bank market makers) was greater in equity markets, which are more automated. This experience is driving the recognition that there is a need for further intensifying the electronification of the fixed income markets as well.

Surveyed buy-side heads of trading are now finding that razor-thin spreads in electronic fixed income markets mean paying the spread can have a negligible impact on fund performance, while it provides them the benefit of pricing visibility, immediacy, continuity of service, and an alternative groundswell of liquidity offered by ELPs.

As fixed income trading is becoming more automated, the generation and consumption of data rises exponentially, in turn creating the ability to adapt trading strategies, blend asset classes, and spot new opportunities. The complexity of resulting next-generation order flow demands algorithmic wheels and smart order routers that can reach into the deep corner-pockets of the markets for liquidity. Accurate post-trade data is prerequisite in this advanced world and therefore there is a concerted push for a comparable level of post-trade transparency in fixed income as for the equities markets.

All of this means it is more critical than ever before to finally deliver on one of the major elusive objectives of European wholesale markets regulation: fixed income transparency. Now that both the EU and UK are reviewing their respective rulebooks, it is critical that the lessons the market learned from Covid 19 and the new emerging trading landscape it created are taken to heart.

In particular, this should be to improve MiFIR post-trade transparency information. Currently, this is of no practical value with weeks-long deferrals. Key practical steps to be taken should be to harmonise the deferral regime to ensure a level playing field while at the same significantly shortening the publication delays for post-trade transparency information. Based on market experience, in particular with the long-standing post-trade transparency regimes in the US, 15 minutes would be an appropriate length of deferral for large size transactions. In parallel, a volume masking regime should be implemented, ensuring that liquidity providers are not exposed to undue risk and are still able to effectively hedge even after the deferral window has expired since the market does not know the full-size of the large trade. Having thus improved quality of post-trade transparency data, the final step should be to create a consolidated tape for bonds which would enable all market participants and, critically, the buy-side, to benefit from a coherent democratised source of relevant pricing information to inform their newly automated execution strategies.

Making these improvements to the fixed income transparency regime now, will further enable buy-side participants to achieve the objective of broadening their sources of liquidity to a wider community of counterparties, and do justice to the new execution landscape we see emerge as Europe recovers from the Covid 19 pandemic.