Bond Market Automation: The Next Step in the Fixed Income Electronic Evolution | October 2019

Bond Market Automation:

The Next Step in the Fixed Income Electronic Evolution
V17-059 | October 2019 | www.tabbgroup.com

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 Bond Market Automation: The Next Step in the Fixed Income Electronic Evolution | October 2019

Table of Contents
Introduction ..................................................................................................................... 3
A History of the Ecosystem ............................................................................................. 4
A Perfect Storm ............................................................................................................... 5
The Age of Automation.................................................................................................... 6
Harder, Faster, Stronger ................................................................................................. 8
Thinking Little, to Think Big ............................................................................................. 9
Conclusion .................................................................................................................... 10
About ............................................................................................................................. 11
TABB Group .............................................................................................................. 11
TABB Group Fixed Income Practice .......................................................................... 11
The Author ................................................................................................................. 11

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 Bond Market Automation: The Next Step in the Fixed Income Electronic Evolution | October 2019

Introduction
The increasing role that data plays in the execution desk’s workflow is central to the electronic
transformation occurring within the US fixed income market. This report details the transformative
steps execution desks are taking to rethink the ways in which automation can be applied to
traditional workflows and how execution protocols such as requests for quote (RFQs) help
participants navigate the modern fixed income landscape.

All of this change has occurred within the context of tremendous growth for the majority of the
US fixed income markets. For US Treasuries and US corporate credit securities in particular,
notional volume outstanding has had major growth in the post-crisis years with UST notional
outstanding more than doubling since 2008 (Exhibits 1 & 2).

Exhibits 1 & 2: US Fixed Income Market Notional Outstanding, $ Billions

Total US Bonds FI Bonds by Market Segment

$46,000
$20,000
$42,000 $15,000

$38,000 $10,000
$5,000
$34,000
$0
2009
2008

2010
2011
2012
2013
2014
2015
2016
2017
2018
$30,000 1H 2019
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
1H 2019

Municipal Treasury MBS

Corporate Agency ABS
Source: TABB Group, SIFMA

The evolution of the market from manual to electronic to automated (and what comes next) is
therefore of vital importance as we consider the ways in which a growing market meets ever-
expanding demand, and how markets for some of the most essential financial assets in the world
move toward modernity.

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 Bond Market Automation: The Next Step in the Fixed Income Electronic Evolution | October 2019

A History of the Ecosystem

The process by which most of fixed income has been electronified so far has been piecemeal,
and most often reserved for highly liquid products whereas new methods of trading have
developed more organically (only for swaps has the change been broadly mandated).

Historically, the interdealer US Treasury market was the first fixed income market in which
participants on both the buy and sell side embraced new electronic workflows on a large scale.
As these mechanisms developed, within the interdealer on-the-run (OTR) securities market in
particular, speed became the name of the game. In the early 2000s, central limit order books
(CLOBs), which match bids and offers on a price-time priority basis similar to an exchange,
experienced a surge of adoption.

The pre-2008 financial crisis environment was a principal driver of this trend. That is, banks were
still the primary liquidity providers (LPs) in the U.S. Treasury market and engaged in both
proprietary trading and agency trading on behalf of clients. The 2008 financial crisis set in motion
the next stage of US Treasury market evolution. New, harsher regulations were established and
the freedom with which banks were once able to make markets significantly waned.

However, as banks retreated new participants stepped forward. Banks quickly came to rely on
liquidity from new, sophisticated trading firms to reduce risks to the balance sheet as well as
continue executing orders on behalf of institutional clients. These independent market makers
and proprietary trading firms (PTFs) accounted for increasing percentages of overall market
volumes in more liquid, low latency markets, and market velocity increased again.

At the same time, the emergence of new institutional products was changing the underlying
dynamics of the marketplace. Over the past five years, fixed income exchange-traded funds
(ETFs) have completed the transformation from a retail-oriented product into a cross-asset,
institutionally accepted financial instrument. Using ETFs for portfolio management, tactical
exposure, access to unique markets, hedging opportunities, as well as using an ETF liquidity
sleeve for strategic exposure has been a major draw for asset managers, pension funds, and
insurance companies. Underpinning this primary/secondary structure is the creation/redemption
process — which has precipitated a surge in overall trading volume and an explosion in volume
of smaller trades. As of June 2019, assets under management for bond ETFs exceeded $1
Trillion, and now account for roughly 20% of ETF AUM globally.

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 Bond Market Automation: The Next Step in the Fixed Income Electronic Evolution | October 2019

Although the instances of electronification are different in each of rates, credit, derivatives and
equities, the broad themes remain: markets are getting faster, trade count is increasing, and
desks are getting smaller, and lighter. Market participants are finding a greater need to be
increasingly agile.

A Perfect Storm
This combination of factors — growing electronification, quickening speed of trading, and the
proliferation of smaller trades as headcount reduces — has created the most compelling
environment yet for automating trading.

Clearly the most liquid and simplest trades are the easiest opportunities for electronic intervention
and innovation. However, as this report examines, growing comfortability with automation is
changing definitions of what constitutes a “simple” trade, with notional value traded starting to
steadily increase.

This has implications for the way a market, which was used to putting relationships at its center,
will operate in the future. Unlike other asset classes within the US capital markets that have been
electronic for some time, the fabled connection of fixed income markets has led to its own distinct
evolution that differs from foreign exchange as well as equities. As an example, the recent surge
in growth of direct streams in on-the-run (OTR) Treasuries, which link new counterparties to each
other bilaterally, the dynamic is changing along with technology.

It therefore seems counterintuitive that automation technology is actually being developed to

reinforce relationships. Seeing the same opportunity to take the smallest liquid bonds off their
trades’ plate to afford them more time to focus on difficult trades, dealers have relied more heavily
on auto quoting capabilities to respond to RFQs.

AllianceBernstein has been one of the most vocal proponents for the bond market to further
transform. Jim Switzer, who heads credit trading at the company was quoted by the Financial
Times earlier this year stating, “The bond market is going to look radically different in three years’
time.” Abbie — an AllianceBernstein “bot” has gained attention this year for its capacity to
automate workflow and assist portfolio managers within the firm trade more effectively and
autonomously scan for opportune bonds. It is currently limited to the junk bond market, but

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 Bond Market Automation: The Next Step in the Fixed Income Electronic Evolution | October 2019

AllianceBernstein is optimistic the capacity can be extended to the larger bond market universe.

Most importantly for market participants is that these tools are becoming available on a wider
distribution scale. For instance, Tradeweb’s Automated Intelligent Execution (AiEX) tool can be
implemented within a day for buy-side firms already active on the firm’s platform. Tradeweb
points out that a major driver of adoption and success with the AiEX system is its access and
offering of tools that require minimal change to existing workflow and technology infrastructure.
Bloomberg’s RBLD for example is a revamped version of a previous tool that allows clients to
utilize the automation through their TSOX portal.

The Age of Automation

The increasing appetite for technological differentiation, efficiency tools, and automation
solutions underscore a greater truth about the future of execution within US fixed income markets:
processes can always be simplified. As a natural extension of this principal, electronic trading
platforms are best positioned to provide the most effective and easiest to onboard automated
trading environments.

In recent months, automation tools have made several headlines as firms roll out new or
expanded automation systems for clients and touted surging volumes that are executed through
automated systems. Tradeweb’s AiEX has recently garnered attention with a strong uptick in
trading through its tool. AiEX, which was initially designed to automate highly liquid low-touch
trading in US Treasuries as far back as 2013, has expanded across 26 different rates, credit,
equities, and derivatives products, while continuing to expand with comprehensive rules and
parameters.

The solution accommodates the fact that there is no “one-size-fits-all” across the spectrum of
clients looking to automate their workflow. Asset managers, hedge funds, ETF desks, and dealer
desks (to name a few) all approach the same markets from different angles. For instance,
Tradeweb has taken a module-based approach with AiEX. This allows for the rules that clients
set in place to replicate their decision-making process to be as simple or complex as needed —
depending on the analytical data utilized.

Although the where and how clients are automating vary, the recognition of its benefits is equal
across fixed income market participants. Recent growth of automated executions on leading fixed

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 Bond Market Automation: The Next Step in the Fixed Income Electronic Evolution | October 2019

income electronic platforms demonstrates this trend. Between 2013 and the first half of 2019, the
percentage of institutional tickets executed on Tradeweb’s platform through automated systems
increased from .77% to 21.58% (Exhibit 3).

Exhibit 3: Tradeweb Automated Trading Growth

25%
21.58%
% of Tradeweb Institional

20%

15% 13.63%
Tickets

11.21% 11.56%
10%
6.45%
5% 2.69%
0.77%
0%
2013 2014 2015 2016 2017 2018 HY 2019

Source: Tradeweb, TABB Group

The scope of fixed income products supported by these new tools vary from provider to provider;
however, the core application and adoption momentum has been with credit, rates, and certain
interest rate and credit derivatives applications focused on auto-executing or reducing the manual
intervention needed for eligible trades. In fact, these automated systems are considered standard
for most government bond desks and are also increasingly mainstream in cash credit market
making (Exhibit4).

Exhibit 4: AiEX Adoption by Market Segment

60% 53%
50%
% of Tradeweb Electronic

50%
Institutional Trades

39%
40% 32% 34% 31%
30% 26%
17% 17% 17% 17%
20% 11%
10%
0%
Treasury European U.S. ETF European U.S. Credit European
traded Gov traded ETF traded Credit

1H 2018 1H 2019

Source: TABB Group, Tradeweb

The first hurdle for buy-side firms looking to implement automation strategies is to determine
which products they are active in are eligible. Once this is determined, it is key to discover which
and how many dealers put in competition. Depending on the client type, the size of the trade, and

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 Bond Market Automation: The Next Step in the Fixed Income Electronic Evolution | October 2019

various other factors such as market liquidity and time sensitivity, a trader can elect a number of
ways to approach the broader market participant tool.

Using Tradeweb’s AiEX ecosystem as an example, for an appropriately sized credit trade, a client
might determine that he or she want to send the order to Tradeweb’s all-to-all pool first to see if
the client can attract both traditional (dealer) and non-traditional (non-dealer) interest.
Alternatively, the same client might prefer to send an order to a select group of dealers he or she
has a relationship with.

This dealer selection process is significantly improved through the robustness of a platform’s pre-
trade tools such as the availability of dealer axes and composite pricing engines. Once the
number of quotes (and to which dealers) the trader wants to solicit is established, a client can set
a time limit for how long he or she is prepared to wait for a quote and acceptable levels for the
quotes that return. In this way, the granular variables of an already straightforward process of
traditional voice RFQ can be systematically performed — and uniquely as a result —
systematically interpreted to improve future trades.

Harder, Faster, Stronger

Proponents of automation, agnostic of offering would agree that a key benefit of the electronic
progress seen within the fixed income marketplace is an aggressive approach to reducing manual
intervention. Clearly, one of the most significant benefits of automation after all is faster execution
(in the realm of hundreds of RFQ trades in seconds). Removing time-consuming manual labor
from the easier trades (which is the original and simplest use case for these automation tools)
can free up a significant amount of the trader’s time to focus on more difficult trades.

Another benefit of setting specific parameters for automation process is the enhancement of the
best execution process. New solutions that utilize a combination of electronic trading metadata,
internal estimates, and public data such as liquidity-scoring mechanisms and pricing engines can
easily be integrated with the automation rule decision making process — which ultimately
reduces the potential for human error or guesswork that can occur especially with illiquid, hard
to price markets.

Finally, the growth in these tools helps foster greater access. Until recently, buy-side firms that
might have been interested in incorporating automation tools into their workflow also have had

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 Bond Market Automation: The Next Step in the Fixed Income Electronic Evolution | October 2019

to weigh the benefits against significant technological limitations principally the up-front costs of
setting up the internal electronic infrastructure. Historically, the largest users of this technology
today have (unsurprisingly) been the largest asset managers across the markets — with the
technology resources and wallet to build out customized solutions. As we considered earlier in
this paper, the strength of automation offerings across dealers, investors, and platforms alike
help to straighten out this asymmetry of access.

Thinking Little, to Think Big

The pieces are already starting to come together to shape a future in which automated trading is
not limited to executing smaller-sized trades. Although block trading is still certainly reserved for
traditional voice trading in which a trader can leverage dealer relationships to receive dealer color
and capital, the traditional <$5MM cap on automated trading that many clients initially
implemented has significantly increased across all markets. Within some segments, automated
trades are regularly executed well above $100MM.

Although the figures above do not demonstrate growth in trade size, it does reflect an increased
willingness on the part of investors to trust an automated system with a greater percentage of
business. That trust is the first step in increasing the baseline trade size thresholds for automated
trading. Recent examples of this trend are the adoption of Swaps Execution Facilities (SEFs) in
the Interest Rate Derivative (IRD) market as well as the recent growth in activity on electronic
corporate bond trading platforms — in which a period of onboarding and performance analysis
is required before wholesale adoption. Recent interviews with buy side treasury traders suggest
that, in general, as the momentum of electronic trading builds, we will likely continue to see a
gradual increase in the percentage automated large trade volume — a percentage that is modest
but growing.

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 Bond Market Automation: The Next Step in the Fixed Income Electronic Evolution | October 2019

Conclusion
In the twenty years since Tradeweb launched the first fully electronic multi-dealer RFQ platform
for the US Treasury market, modern fixed income innovations are still being built upon that
platform’s founding principle: find a process that works and make it easier.

The reality today is that for an increasingly technology-conscientious fixed income market, it is
becoming clear that two different traders with the same strategy and same goal can potentially
experience drastically different results based on their use of the data, tools, and protocols.
Varying methods with which platforms have begun to apply analytics to internal and public trade
data and metadata have resulted in a rich ecosystem of actionable data for electronic
participants. New liquidity metrics, granular counterparty comparison tools, pre-trade data
streams, and fixed income trade cost analysis (TCA) innovations continue to improve as the pool
of participants and level of trading occurring on electronic venues grows.

Automation solutions that offer a rules-based approach to tailoring the data to execution
expectations are the next step in taking full advantage of an electronic trading ecosystem. A
surge in volume traded via automated systems is a clear appeal to a widening pool or
participants. Although automated trading’s initial application may have been limited to gaining
efficiencies for “simple trades”, the broader history of electronification in fixed income markets
suggests that the benchmark for “simple” will rapidly change in sophistication as the pool of users
continue to grow.

The extent to which automation technology and electronic trading solutions will integrate with or
replace traditional trade workflow will not only impact the way in which fixed income trades, but
the skillsets required of the traders themselves. As the benefits of these tools is additionally
recognized, and use of them continue to spread across disparate fixed income markets such as
rates and cash bonds (and increasingly in new classes such OTC interest rate and credit
derivatives and ETFs), a new class of generalists will be required to bridge the electronic process
gap between disparate yet increasingly interconnected electronic markets.

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 Bond Market Automation: The Next Step in the Fixed Income Electronic Evolution | October 2019

About

TABB Group
TABB Group is a financial markets research and strategic advisory firm focused exclusively on
capital markets. Founded in 2003 and based on the methodology of first-person knowledge,
TABB Group analyzes and quantifies the investing value chain, from the fiduciary and investment
manager to the broker, exchange, and custodian. Our goal is to help senior business leaders
gain a clearer understanding of issues and trends within financial markets, so they can better
grow their businesses. TABB Group members are regularly cited in the press and speak at
industry conferences. For more information about TABB Group, visit http://www.tabbgroup.com/.

TABB Group Fixed Income Practice

TABB Group’s Fixed Income research examines trading, operational and technology issues
impacting corporate bonds, treasuries, swaps, and other credit and rate derivatives in North
America, Europe and Asia. This includes deep dives on market structure, business models,
execution venues, central clearing, prime brokerage, technology, market data, and compliance.
Our research is used by legislators, regulators and market participants worldwide to make
strategic and policy decisions surrounding fixed income trading and OTC derivatives reform.

The Author
Colby Jenkins, Analyst
cjenkins@tabbgroup.com

Colby Jenkins joined TABB Group in August 2012. Before joining TABB, he was a Global
Academic Fellow at New York University Abu Dhabi in the UAE, serving as a faculty member in
their physics and mathematics departments. He graduated from New York University, earning a
BS in physics with additional focus on mathematics. As an analyst, Colby works within both the
TABB consulting service and the fixed income research group.

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 Bond Market Automation: The Next Step in the Fixed Income Electronic Evolution | October 2019

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