The Future of Electronic Fixed Income Trading-- Cash and Derivatives: Regulation and Dealer Economics Spur Innovation in Dealer-to-Client Markets

by David Easthope,  Joséphine de Chazournes, August 27, 2012
EMEA, North America

Abstract

The economics of fixed income dealing operations is evolving due to market structure changes, emerging regulations, and disruptive technologies already in the market and on the horizon. As new regulations continue to put pressure on revenue models, firms are investing in innovation in areas such as trading models, price discovery, and trading technology.

In the report, The Future of Electronic Fixed Income Trading--Cash and Derivatives: Regulation and Dealer Economics Spur Innovation in Dealer-to-Client Markets, Celent dissects trends and developments in the fixed income trading value chain and explores how regulation and revenue pressures are fostering innovative designs in the marketplace.

The fixed income trading value chain is evolving more significantly than any other across the range of asset classes. Whereas FX and equities underwent significant transformations toward electronic platforms and technology supporting trading workflow years or even decades ago, fixed income is only just catching up.

Some of this evolution is industry-led due to declining profits and a desire to improve efficiency by leveraging technology, but most of it is due to factors outside the industry’s control, as a myriad of national and multinational regulatory efforts strain business models, force capital optimization, and mandate certain clearing models. Major initiatives include Basel III, the Volcker rule, EMIR, Dodd-Frank and MiFID2 in Europe.

“The net result of these regulatory initiatives will severely impact dealer models, putting pressure on revenues, and thus liquidity in secondary markets,” says Josephine De Chazournes, Senior Analyst with Celent’s Securities & Investments Group and coauthor of the report.

“Due to the impact on liquidity and dealer models, a number of firms are investing in innovative business designs,” adds David Easthope, Senior Analyst with Celent’s Securities & Investments Group and coauthor of the report. “Innovation in cash markets is occurring in areas such as trading models, price discovery, and trading technology.”

This report examines the evolution of fixed income, developments in the value chain, and the evolution of liquidity and trading. Celent identifies innovative new business designs in fixed income trading models, price discovery and trading technology. The report also provides market scenarios for different instrument classes in the US and Europe.

This 36-page report contains 5 figures.

Celent is a research and advisory firm dedicated to helping financial institutions formulate comprehensive business and technology strategies. Celent publishes reports identifying trends and best practices in financial services technology and conducts consulting engagements for financial institutions looking to use technology to enhance existing business processes or launch new business strategies. With a team of internationally based analysts, Celent is uniquely positioned to offer strategic advice and market insights on a global basis. Celent is a member of the Oliver Wyman Group, which is a wholly-owned subsidiary of Marsh & McLennan Companies [NYSE: MMC].

Media Contacts

North America
Michele Pace
mpace@celent.com
Tel: +1 212 345 1366

Europe (London)
Chris Williams
cwilliams@celent.com
Tel: +44 (0)782 448 3336

Asia (Tokyo)
Yumi Nagaoka
ynagaoka@celent.com
Tel.: +81 3 3500 3023

Table of Contents

Executive Summary

3

The Great Evolution of Fixed Income

3

 

Innovation Is Being Spurred

3

 

Predicted Trading Models

4

Introduction

5

 

Scope of Coverage of This Report

5

 

The Idiosyncrasies of Fixed Income

5

 

Purpose of This Report

6

The Evolution of the Fixed Income Trading Value Chain

7

 

Regulatory Drivers

7

 

Technology Drivers

8

 

Resulting Technology Needs

9

The Evolution of Fixed Income Trading and Liquidity

11

 

The Issue of Capital

11

 

The Decline of the Fixed Income Revenue Pool

12

 

Dealers Transforming Operations

14

 

Buy Side Under Pressure

15

The Evolution of Electric Trading in Fixed Income

17

 

Algorithmic Trading

17

 

Algorithmic Trading in Fixed Income

17

Innovation Business Designs in Fixed Income Trading

19

 

The Innovation Cycle

19

 

Innovation Trading Models

20

 

Innovation Price Discovery Models

27

 

Innovation Trading Technology

28

Market Scenarios Based on Innovations

32

 

US Cash

32

 

US Derivatives

32

 

European Cash

32

 

European Derivatives

32

Conclusions

35

Leveraging Celent’s Expertise

36

 

Support for Financial Institutions

36

 

Support for Vendors

36

Related Celent Research

37

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