Exchange Model Not for Fixed Income, Experts Argue

Securities Industry News :: By Alexa Jaworski, Markets Reporter: " Despite the advent of electronic trading, bond markets still are not suited for the type of centralized exchange that facilitates trading in many equities and derivatives products. That was the consensus of a panel of fixed-income industry technology leaders at a Bond Market Association conference this week in New York.

Past attempts to bring an exchange style into fixed-income trading haven't succeeded because these markets, especially the corporate and high-yield asset classes, "tend to be so fragmented that it's very difficult to create continuous liquidity, electronic or otherwise," Richard McVey, chairman, president and CEO of e-trading platform MarketAxess, said during the BMA's Fixed-Income Summit & Expo.

The exchange model in equities, for example, is based on matching of buy and sell orders, making it different from the dealer-driven fixed-income markets, said Rob Slaymaker, CEO of BondDesk Group, which operates an online marketplace for primarily retail bond brokers. "It doesn't mean we're not going to evolve to that point, and I think the verdict is still out as to whether it will be successful at least on the retail side," he said, though he acknowledged that "there are some advantages to the exchange model, which does eliminate some of the counterparty exposure you would get when you have a large number of smaller participants on the platform."

Chris Pike, a partner with Advent International, a private equity firm that has invested in several electronic trading ventures, said it comes down to structural differences in the markets that make it hard for bonds to fit efficiently in an exchange framework. "I would say it seems less likely that bonds will find their way into an exchange, but the advances [in current trading venues] have surprised me consistently," he said.

Mike Cormack, president of Archipelago Holdings, an exchange operator that is eyeing bond trading as well as merging with the New York Stock Exchange, referred to that transaction more as a "technology play" than a deliberate move into the exchange space. "I think people will look at us on the merits of the performance of our systems and the functionality we provide, rather than whether or not it trades on an exchange," he said.

The panelists at the Wednesday conference disagreed on whether or not the fixed-income e-trading sector will continue to see consolidation alongside the push toward offering multiple asset classes on one platform.

Noting that the number of electronic fixed-income platforms once exceeded 100 and has dwindled to a few major players, Jim Toffey, president of equities at Thomson Financial and head of Thomson TradeWeb, said consolidation will be a natural consequence of critical mass in the relevant liquidity pools. "What we've found over time is that liquidity centers around two to three platforms in any one type of asset class," he said. "So I think that's a rule of thumb. In asset classes where you see five or more platforms, you can look for consolidation there."

Added Slaymaker: "When you talk about getting to new markets, to really grow or drive our business toward growth, you really need to do it through consolidation or acquisition of another company."

However, McVey emphasized that the industry has already seen a significant wave of consolidation. "The liquidity pools have been established [and] the barriers to entry are growing," he said. "I think there have been some tremendous examples of combinations and transactions in the equity space this year that have driven shareholder value. And if there are more opportunities to do that in the future in fixed income, I'm sure we will all find them, but the industry has gone through a significant amount of consolidation around e-trading in the last four or five years."

At the same time, McVey continued, customers are demanding that a greater range of products be offered on one platform. "From my perspective, it's all about maximizing the value on the desktop space," he said. "This has been a big year for us in terms of client connectivity and direct connections with order management systems. We think that's part of what's driving the volume and trading growth and part of what's driving the demand to expand into the new product areas.""