Industry Inertia Hampers E-Trading

Phones, faxes and manual versus fully automated, fast and efficient. You'd think that the automated and efficient solution would win, especially in today's tough marketplace as financial firms strive to lower costs and look for efficiencies throughout the business.

Fixed Income TransformationWall Street & Technology's May 2013 digital issue takes an in-depth look at the transition fixed income markets are making to electronic trading as the search for liquidity intensifies and regulatory reform looms. To read more, download our May 2013 digital issue now.

But sometimes inertia -- the tendency to continue to do the same thing day after day, year after year -- prevails. Inertia is certainly evident in the fixed income trading space, where a large portion of trading still happens via voice communications even though automated trading technology has existed for years. Today, 76% of institutional fixed income trading continues to be conducted by voice (phone), according to TABB Group. In the equities space, where the shift to e-trading started more than a decade ago, virtually all transactions are electronic.

So why hasn't electronic trading in the fixed income market taken off? There are a variety of reasons, including a lack of a regulatory push and the desire to maintain existing business models.

In the equities space, the shift to decimalization in 2001 and Reg NMS implementation in 2007 pushed traders to adopt electronic methods. In fixed income, those sorts of regulatory mandates haven't happened. Although certain regulations -- such as Dodd-Frank in the United States and MiFID II and the European Market Infrastructure Regulation in Europe -- may push markets to electronic trading, the rules haven't been finalized.

Vested Interests

In addition, the current business model that involves intermediate brokers is working. Most trading in fixed income involves interdealer brokers, who claim to help find liquidity, enhance price discovery, improve market efficiency and lower costs. It's also worth noting that providing these intermediary services is a profitable business. As a result, the desire to move to a more electronic process -- one that actually could disintermediate IDBs -- may not be in their best business interest.

[Where’s The Growth In The Electronic Bond Market?]

However, institutional traders see some value in fixed income electronic trading. For starters, it's easier to anonymously achieve price discovery. In a trading model where voice transactions are predominant, traders must contact brokers to find pricing and liquidity, which may lead to information leakage (something that buy-side traders try to avoid at all cost). Also, electronic trading allows for easier post-trade transaction cost analysis and the ability to find the best execution.

Eventually, regulatory changes, business pressures and the evolution of technology will move fixed income trading to electronic trading methods. It may take a few years, but the shift is likely inevitable once all of the players -- investors and brokers -- see value in the model.