Beyond the point of no return
11 October 2022
Industry participants have witnessed steady growth in the use of electronic trading in the securities finance sector and this is expected to accelerate over the years ahead. Carmella Haswell examines the impact of automation and how the continued advance of electronic trading will impact the market
Image: stock.adobe.com/sdecoret
Technology firms are needing to adapt to survive in an industry where market participants are demanding and expecting increasing levels of automation to maintain position. Despite being years from a fully-electronic world, electronic trading is leading decision making in the repo markets.
The way that trading platforms have expanded across different asset classes over the past two decades has characterised the digital transformation across capital markets, according to Ed Tyndale-Biscoe, head of secured funding product development at ION Markets.
As a global provider of technology to firms across all asset classes, ION Markets’ view of the world is built on the foundation of electronic trading. Tyndale-Biscoe explains: “We ensure that our technology evolves at the same pace as that in which the markets provide. The core values that we have when designing solutions are simplifying and automating workflows, improving efficiency, and empowering users’ decision making.”
Electronic trading is defined by the International Capital Market Association (ICMA) as the execution of a contract across an electronic platform. In December 2021, 26.8 per cent of the outstanding value of repo business reported had been executed on an automated trading system (ATS) — an electronic repo trading method.
The ICMA’s “European Repo Market Survey: Electronic trading in the European repo market” suggests that most repos traded on an ATS are short-term, meaning that they “run off” quickly between survey reporting periods. As a result, a significant percentage of these trades are not being captured. The survey reads: “In terms of turnover (flow) data, which include all new transactions over a period, ATS would take a much larger share. Using UK and EU Securities Financing Transactions Regulation (SFTR) data on trading venues as a proxy suggests 53-58 per cent at end-2021. The ATS share of interdealer trading is likely to be even higher.”
Global head of BrokerTec at CME Group, John Edwards, says electronic trading within the dealer-to-dealer (D2D) markets has been established for a long time, but continues to evolve. BrokerTec Quote — a dealer-to-client (D2C) request for quote (RFQ) trading solution for the European and US repo markets — is experiencing an “interesting” period of innovation within the repo space. This comes in response to regulatory changes, in particular SFTR, which has altered the market and outlook for electronic execution, according to Edwards.
“Electronic trading is about delivering efficiency to a market,” Edwards notes. “Repo is typically not a high frequency, fast moving product. This is about order management — trying to build liquidity pools which give real value to customers in terms of a one-stop venue, so they can execute the vast majority of their business.”
The key to creating a fully electronic market revolves around three pillars, according to Madhu Subbu, head of securities finance engineering at Clear Street. These include electronic distribution of market data, electronic order management and electronic matching.
Reflecting on the history of the cash equities market, Subbu explains that these three pillars were largely in place by the late 1990s, which saw volumes explode, reduced trading costs and a participation increase. Compared to the stock loan market, the three pillars are in place to varying degrees, but not at the level of the cash equities market.
ION Market’s Tyndale-Biscoe concludes: “As the level of expectation in trading platforms increases, participants are demanding, and expecting, increasing levels of automation to maintain position and to drive more efficient management of scarce resources, in line with the requests that we are hearing from our clients.
“In terms of the transition, it is not anywhere near complete to a fully electronic world. There are still a number of challenges and uncertainties around the path to that.”
Changing trading needs
The value of electronic trading within the repo markets is three-fold, according to Clear Street’s Subbu. Firstly, it provides scale and market throughput; in the securities lending market for US equities, utilisation has historically averaged around 3 to 5 per cent.
Secondly, electronic trading allows for price discovery for market participants — when a market moves to electronic trading, price discovery tends to improve and prices converge. Thirdly, it provides market access as participation increases when the market becomes more electronic.
With a multitude of factors impacting the evolving electronic trading environment, Clear Street is noticing a change in client trading needs. Subbu explains: “Most prominently, securities lending used to be a rather niche corner of the market, but that has changed thanks to players like Robinhood and the other new-age brokers. There is also a broader understanding of shorting in the market, which means there is more demand for securities lending. We are generally seeing participation go up as a result.”
Tradeweb’s head of European fixed-income Nicola Danese suggests that client needs have changed particularly as a result of the pandemic and the shift to work from home, as this has reinforced the merits of automation and electronic trading solutions. Additionally, technology development and regulation have become drivers in changing trading needs, particularly as a result of the Central Securities Depositories Regulation and settlement penalties.
Building on this point, CME Group’s Edwards notes: “MiFID II was an alarm call to the securities lending, and particularly the repo, markets, knowing that SFTR was coming and would seek to make similar changes for these markets. It was a real catalyst in driving the adoption of electronic trading in the direct-to-customer (D2C) environment.”
Prior to the introduction of SFTR, the D2C market was “very slow” to adopt electronic trading, especially when compared to rates or other fixed-income markets, Edwards explains. He continues: “SFTR was the catalyst for greater adoption and demand and a big driver of why we recognised the opportunity to get into the D2C market in 2019.”
Tradeweb’s Danese reflects on the hesitancy from clients to embrace technology, owing to the fact that the repo market is a relationship-based business. “There was a desire not to push too hard towards electronification, although the merits were absolutely acknowledged,” Danese comments. "Some clients, rightly or wrongly, had the perception that the relationship aspect could have been diluted by automation. They now see the merits in their day-to-day trading activity with simplified, more efficient, automated workflows.”
Adding that the “proof is in the numbers”, Danese announces that in EUR terms, Tradeweb’s institutional global repo platform saw a 14 per cent increase in average daily volume in the second quarter of 2022 year-over-year.
A greater impact
In the repo market, the adoption of electronic trading continues at pace and is expanding across other flows, where traditionally it was more widely used on the interdealer markets for trading more liquid assets over short terms, ION Market’s Tyndale-Biscoe explains. Although repo has been slower to embrace electronic trading, and remains behind the curve, it is definitely catching up.
Tyndale-Biscoe adds: “We are seeing significant demand from our clients when it comes to managing RFQs for those participants that, historically, have not been able to access the interdealer liquidity, or where there is a demand for less liquid, more structured, or longer term types of deals.”
In response to this trend, ION Markets has extended its solution on the interdealer markets and trade processing to simplify the sales-to-trader workflow through the use of an order management solution. The firm predicts that as more participants automate their flows and leverage the benefits of that model, this will become the default and, eventually, “the only way to do that business”.
Evaluating its impact on the repo market, CME Group’s Edwards says the advancement of electronic trading has provided greater transparency in the dealer-to-dealer (D2D) space, which has supported the market and allowed further growth. Over the past few years, Europe has seen close to double-digit growth in terms of nominal volume transacted. More recently, the US has seen a significant increase in volume activity, Edwards informs.
He continues: “We have seen new record highs frequently over the last eight months or so. Often traders are not fully aware of the increase in activity from one day to the next and this is a testament to the efficiency of electronic trading, in that if their financing needs are much greater today versus yesterday, the market has the ability to absorb that and allow them to transact seamlessly.”
Currently, there are two key developments in the stock loan market that could move electronification forward, notably electronic matching at scale and new clearing models. Clear Street’s Subbu explains: “When I came to Clear Street, I brought with me Enigmatch’s technology, which possesses the unique ability to match complex financial contracts at scale, including stock loan and repo.” In terms of new clearing models, the DTCC’s Securities Financing Transaction CCP offering is expected to alleviate capital constraints for participants and increase participation.
Despite its positive impact, the market is facing new challenges and risks from electronic trading as the industry seeks to answer pressing questions on fragmentation, interoperability and data hygiene — questions of how to deal with different channels for liquidity and availability, and how to get these systems to interoperate in a seamless way, cleaning, normalising and processing all of that information in a world with increasing volumes of data.
Tyndale-Biscoe says: “The risk is that a lot of legacy tech still remains. These closed or proprietary systems present something of a block to fully realising the benefits of electronic trading. But the industry is working very hard to address this and there are a number of initiatives, not just SFTR and the common domain model (CDM), but there is transaction reporting generally and lifecycle modelling to help standardise that processing.”
However, vendors can play a big part in helping the market navigate this, in particular, through the use of cloud, artificial intelligence (AI), covering data science, and machine learning, which make greater use of predictive analytics to help and improve confidence in decision making and risk management.
Clear Street believes that margins are under pressure because there is no more price transparency. “Customers are also demanding a frictionless user experience. They want access to a broad range of inventory at good prices. That is the pressure electronic trading has put on participants like us,” Subbu adds.
On the horizon
As the integration of electronic trading spreads across the securities finance and lending industries, market participants reflected on what is next to come from this technology phenomenon.
“For quite some time, people were still unsure if electronification was going to happen — it has happened, and we are beyond the point of no return,” says Tradeweb’s Danese. “We see other powerful forces at play, like the removal of some of the accommodative monetary policies that are expected to give further impetus to the automation of repo as a product.”
As part of the solutions in post-trade, the mention of distributed ledger technology (DLT) is increasing. Although too early to know if DLT is going to address the settlement challenges, Danese expects further impetus in automation, electronification and new solutions in that space.
Through the evolution of electronic trading, the market is likely to see continuing initiatives to support additional workflows and broader asset class coverage.
In terms of Tradeweb’s own evolution, Danese names repo to be the “lifeblood” of the financial markets. He continues: “It is particularly important for us to have a good repo offering, because providing liquidity in the repo market enhances the liquidity of the cash markets. I will go one step further, it is not just about repo for us, but it is also about financing. We are looking at the entire financing ecosystem.”
CME Group’s Edwards expects to continue to see growth in the marketplace over the next five years, with sponsored clearing singled out as an interesting area for development — which is supported on BrokerTec Quote in the D2C space.
In terms of its own evolution, BrokerTec is still within its growth phase in terms of the D2C under BrokerTec Quote and its focus will be on extending collateral types — specifically, different fixed-income securities available for traders to execute a repo transaction. He concludes: “There is an increase in demand and appetite to trade repo as a floating rate or spread, rather than a fixed-rate repo. The driver for this is the changing and upward interest rate environment, to provide more protection and hedge in terms of further rate changes. We are keen to maintain our strong service and platform as the place to go to trade repo.”
Clear Street’s Subbu predicts that the securities lending market is going to see an increased amount of electronic matching, combined with central clearing. The securities lending and repo market could also see the emergence of multiple venues and multiple liquidity pools. “Over time, they will likely consolidate, just like in the cash equities market. The ones with the best user experience, customer service, and the widest inventory, will probably win out.” Subbu comments.
“The past few years, and certainly the past few months, have shown the unpredictable nature of what goes on in the global economy and the impact that it has directly on capital markets, secured funding, and all the different areas of the business. The fact that electronic trading has continued to expand during that period is real testament to the high level of quality and reliability of the systems that we have in place,” concludes Tyndale-Biscoe.
Over the next five years, it is very unlikely that the market will see a complete absence of humans from making trading decisions, Tyndale-Biscoe advises. However, there will be a shift toward automated decision making. Additionally, there will be growing emphasis on the transparency and ESG-related aspects of decision making, alongside steps to support greater flexibility around trading in digital assets.
The way that trading platforms have expanded across different asset classes over the past two decades has characterised the digital transformation across capital markets, according to Ed Tyndale-Biscoe, head of secured funding product development at ION Markets.
As a global provider of technology to firms across all asset classes, ION Markets’ view of the world is built on the foundation of electronic trading. Tyndale-Biscoe explains: “We ensure that our technology evolves at the same pace as that in which the markets provide. The core values that we have when designing solutions are simplifying and automating workflows, improving efficiency, and empowering users’ decision making.”
Electronic trading is defined by the International Capital Market Association (ICMA) as the execution of a contract across an electronic platform. In December 2021, 26.8 per cent of the outstanding value of repo business reported had been executed on an automated trading system (ATS) — an electronic repo trading method.
The ICMA’s “European Repo Market Survey: Electronic trading in the European repo market” suggests that most repos traded on an ATS are short-term, meaning that they “run off” quickly between survey reporting periods. As a result, a significant percentage of these trades are not being captured. The survey reads: “In terms of turnover (flow) data, which include all new transactions over a period, ATS would take a much larger share. Using UK and EU Securities Financing Transactions Regulation (SFTR) data on trading venues as a proxy suggests 53-58 per cent at end-2021. The ATS share of interdealer trading is likely to be even higher.”
Global head of BrokerTec at CME Group, John Edwards, says electronic trading within the dealer-to-dealer (D2D) markets has been established for a long time, but continues to evolve. BrokerTec Quote — a dealer-to-client (D2C) request for quote (RFQ) trading solution for the European and US repo markets — is experiencing an “interesting” period of innovation within the repo space. This comes in response to regulatory changes, in particular SFTR, which has altered the market and outlook for electronic execution, according to Edwards.
“Electronic trading is about delivering efficiency to a market,” Edwards notes. “Repo is typically not a high frequency, fast moving product. This is about order management — trying to build liquidity pools which give real value to customers in terms of a one-stop venue, so they can execute the vast majority of their business.”
The key to creating a fully electronic market revolves around three pillars, according to Madhu Subbu, head of securities finance engineering at Clear Street. These include electronic distribution of market data, electronic order management and electronic matching.
Reflecting on the history of the cash equities market, Subbu explains that these three pillars were largely in place by the late 1990s, which saw volumes explode, reduced trading costs and a participation increase. Compared to the stock loan market, the three pillars are in place to varying degrees, but not at the level of the cash equities market.
ION Market’s Tyndale-Biscoe concludes: “As the level of expectation in trading platforms increases, participants are demanding, and expecting, increasing levels of automation to maintain position and to drive more efficient management of scarce resources, in line with the requests that we are hearing from our clients.
“In terms of the transition, it is not anywhere near complete to a fully electronic world. There are still a number of challenges and uncertainties around the path to that.”
Changing trading needs
The value of electronic trading within the repo markets is three-fold, according to Clear Street’s Subbu. Firstly, it provides scale and market throughput; in the securities lending market for US equities, utilisation has historically averaged around 3 to 5 per cent.
Secondly, electronic trading allows for price discovery for market participants — when a market moves to electronic trading, price discovery tends to improve and prices converge. Thirdly, it provides market access as participation increases when the market becomes more electronic.
With a multitude of factors impacting the evolving electronic trading environment, Clear Street is noticing a change in client trading needs. Subbu explains: “Most prominently, securities lending used to be a rather niche corner of the market, but that has changed thanks to players like Robinhood and the other new-age brokers. There is also a broader understanding of shorting in the market, which means there is more demand for securities lending. We are generally seeing participation go up as a result.”
Tradeweb’s head of European fixed-income Nicola Danese suggests that client needs have changed particularly as a result of the pandemic and the shift to work from home, as this has reinforced the merits of automation and electronic trading solutions. Additionally, technology development and regulation have become drivers in changing trading needs, particularly as a result of the Central Securities Depositories Regulation and settlement penalties.
Building on this point, CME Group’s Edwards notes: “MiFID II was an alarm call to the securities lending, and particularly the repo, markets, knowing that SFTR was coming and would seek to make similar changes for these markets. It was a real catalyst in driving the adoption of electronic trading in the direct-to-customer (D2C) environment.”
Prior to the introduction of SFTR, the D2C market was “very slow” to adopt electronic trading, especially when compared to rates or other fixed-income markets, Edwards explains. He continues: “SFTR was the catalyst for greater adoption and demand and a big driver of why we recognised the opportunity to get into the D2C market in 2019.”
Tradeweb’s Danese reflects on the hesitancy from clients to embrace technology, owing to the fact that the repo market is a relationship-based business. “There was a desire not to push too hard towards electronification, although the merits were absolutely acknowledged,” Danese comments. "Some clients, rightly or wrongly, had the perception that the relationship aspect could have been diluted by automation. They now see the merits in their day-to-day trading activity with simplified, more efficient, automated workflows.”
Adding that the “proof is in the numbers”, Danese announces that in EUR terms, Tradeweb’s institutional global repo platform saw a 14 per cent increase in average daily volume in the second quarter of 2022 year-over-year.
A greater impact
In the repo market, the adoption of electronic trading continues at pace and is expanding across other flows, where traditionally it was more widely used on the interdealer markets for trading more liquid assets over short terms, ION Market’s Tyndale-Biscoe explains. Although repo has been slower to embrace electronic trading, and remains behind the curve, it is definitely catching up.
Tyndale-Biscoe adds: “We are seeing significant demand from our clients when it comes to managing RFQs for those participants that, historically, have not been able to access the interdealer liquidity, or where there is a demand for less liquid, more structured, or longer term types of deals.”
In response to this trend, ION Markets has extended its solution on the interdealer markets and trade processing to simplify the sales-to-trader workflow through the use of an order management solution. The firm predicts that as more participants automate their flows and leverage the benefits of that model, this will become the default and, eventually, “the only way to do that business”.
Evaluating its impact on the repo market, CME Group’s Edwards says the advancement of electronic trading has provided greater transparency in the dealer-to-dealer (D2D) space, which has supported the market and allowed further growth. Over the past few years, Europe has seen close to double-digit growth in terms of nominal volume transacted. More recently, the US has seen a significant increase in volume activity, Edwards informs.
He continues: “We have seen new record highs frequently over the last eight months or so. Often traders are not fully aware of the increase in activity from one day to the next and this is a testament to the efficiency of electronic trading, in that if their financing needs are much greater today versus yesterday, the market has the ability to absorb that and allow them to transact seamlessly.”
Currently, there are two key developments in the stock loan market that could move electronification forward, notably electronic matching at scale and new clearing models. Clear Street’s Subbu explains: “When I came to Clear Street, I brought with me Enigmatch’s technology, which possesses the unique ability to match complex financial contracts at scale, including stock loan and repo.” In terms of new clearing models, the DTCC’s Securities Financing Transaction CCP offering is expected to alleviate capital constraints for participants and increase participation.
Despite its positive impact, the market is facing new challenges and risks from electronic trading as the industry seeks to answer pressing questions on fragmentation, interoperability and data hygiene — questions of how to deal with different channels for liquidity and availability, and how to get these systems to interoperate in a seamless way, cleaning, normalising and processing all of that information in a world with increasing volumes of data.
Tyndale-Biscoe says: “The risk is that a lot of legacy tech still remains. These closed or proprietary systems present something of a block to fully realising the benefits of electronic trading. But the industry is working very hard to address this and there are a number of initiatives, not just SFTR and the common domain model (CDM), but there is transaction reporting generally and lifecycle modelling to help standardise that processing.”
However, vendors can play a big part in helping the market navigate this, in particular, through the use of cloud, artificial intelligence (AI), covering data science, and machine learning, which make greater use of predictive analytics to help and improve confidence in decision making and risk management.
Clear Street believes that margins are under pressure because there is no more price transparency. “Customers are also demanding a frictionless user experience. They want access to a broad range of inventory at good prices. That is the pressure electronic trading has put on participants like us,” Subbu adds.
On the horizon
As the integration of electronic trading spreads across the securities finance and lending industries, market participants reflected on what is next to come from this technology phenomenon.
“For quite some time, people were still unsure if electronification was going to happen — it has happened, and we are beyond the point of no return,” says Tradeweb’s Danese. “We see other powerful forces at play, like the removal of some of the accommodative monetary policies that are expected to give further impetus to the automation of repo as a product.”
As part of the solutions in post-trade, the mention of distributed ledger technology (DLT) is increasing. Although too early to know if DLT is going to address the settlement challenges, Danese expects further impetus in automation, electronification and new solutions in that space.
Through the evolution of electronic trading, the market is likely to see continuing initiatives to support additional workflows and broader asset class coverage.
In terms of Tradeweb’s own evolution, Danese names repo to be the “lifeblood” of the financial markets. He continues: “It is particularly important for us to have a good repo offering, because providing liquidity in the repo market enhances the liquidity of the cash markets. I will go one step further, it is not just about repo for us, but it is also about financing. We are looking at the entire financing ecosystem.”
CME Group’s Edwards expects to continue to see growth in the marketplace over the next five years, with sponsored clearing singled out as an interesting area for development — which is supported on BrokerTec Quote in the D2C space.
In terms of its own evolution, BrokerTec is still within its growth phase in terms of the D2C under BrokerTec Quote and its focus will be on extending collateral types — specifically, different fixed-income securities available for traders to execute a repo transaction. He concludes: “There is an increase in demand and appetite to trade repo as a floating rate or spread, rather than a fixed-rate repo. The driver for this is the changing and upward interest rate environment, to provide more protection and hedge in terms of further rate changes. We are keen to maintain our strong service and platform as the place to go to trade repo.”
Clear Street’s Subbu predicts that the securities lending market is going to see an increased amount of electronic matching, combined with central clearing. The securities lending and repo market could also see the emergence of multiple venues and multiple liquidity pools. “Over time, they will likely consolidate, just like in the cash equities market. The ones with the best user experience, customer service, and the widest inventory, will probably win out.” Subbu comments.
“The past few years, and certainly the past few months, have shown the unpredictable nature of what goes on in the global economy and the impact that it has directly on capital markets, secured funding, and all the different areas of the business. The fact that electronic trading has continued to expand during that period is real testament to the high level of quality and reliability of the systems that we have in place,” concludes Tyndale-Biscoe.
Over the next five years, it is very unlikely that the market will see a complete absence of humans from making trading decisions, Tyndale-Biscoe advises. However, there will be a shift toward automated decision making. Additionally, there will be growing emphasis on the transparency and ESG-related aspects of decision making, alongside steps to support greater flexibility around trading in digital assets.
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