Mostly… fixed income and cross product eTrading

February 1, 2007

Viva the Revolution: Price makers/takers? Algos in the FI space?

Filed under: Algos, etrading, Mifid, Nuts and Bolts — holky @ 2:31 pm

Some axe grinding in response to Waratahpost geeing up his readers to challenge the status quo-

 Banks make prices and Funds take prices
– Algo trading isn’t for Fixed Income

There is no fundamental barrier between making prices and taking prices, but those making a living market making are by nature going to need to be good at sticking their prices out in whatever shop front and enticing customers to trade, whereas those on the customer side need to have honed their skills to know where to shop for the best opportunities to get the deal they want.   My post a while ago suggested “executable bid lists” might give the ability for top tier customers to send their inventory requests in executable form to dealers – I expect we will enjoy an increase in this activity as direct customer to dealer connectivity increases, and this is offered by dealers as a value-add for their top customers.

The difficulties in a market maker doing this for all of their customers in processing unsolicited requests from many thousand customers at one time is purely “scale”.  You can’t just present each request as a popup msg to the trader to manually decide (like many did in the early days of Tradeweb’s mybid/myoffer in the $ treasury market).  The machine needs to be able to work out whether to accept or not – which gets us onto Algos.

The other point about this is why is the customer sending in their price. I can see a join between an OMS generating the orders needed to execute a particular move in a portfolio (adjusting overall duration or whatever), but would you want customers to have a gui on one of the platforms to just send you their own price … without your machine on the receiving end being able to instantly auto-reject all the crap?

So Algos in the fixed income space. You will find algos in fixed income, in pricing engines. The easiest place to start with this is responding to RFQ (because at that point you have a reasonably narrow set of data to crunch). So your algos look at all of the relevant data related to the inquiry in question and return the “right” price. Of course once you trust your algo to be able to do that, letting it loose market making on your order driven markets is just scaling this up – after all, it’s just a broader selection of inventory, still with a specific type of counterparty at the other end.   If you need to handle executable bid-lists/IoIs where customers send in what they want and the price they’ll do it you’d need the RFQ processing and the ability to accept when the customers price is “close enough”, determined by how much you want/dont want the position.

Conventional wisdom suggests that the demand for customer-facing algos in the fixed income space will increase after they sort out their algos for FX.   I also see the MiFID triggered changes in the exchange markets putting OTC closer on the algo radar too, as the re-engineering to make the existing (exchange focused) algos able to deal with fragmented liquidity does mean they are architecturally similar to what would be required in OTC markets.  Why would a client not wish to utilise algorithms to systematically go-get their best execution?  Of course the fundamental problem then will be whether the fixed income quotes the algos are relying on are truly executable or not – which is another item I’ve already added to waratah’s list.



  1. Speaking of this sellside/buyside cross over: one thing I can never understand about the, albeit small number, of hedge funds interested in being part of an MTS type system. Clearly anonymity is an advantage….but as a taker they are confronted with wider bid-offer than on a B2C platform and as a maker they are obliged to quote for certain periods etc….hardly in common with the freedom a Hedgie expects.

    On algo trading, one of the biggest barriers, as I understand it, will be the relative cost of settling bonds vs. equities, FX etc.

    Any thoughts Holky? Genuine STP would have to help there, but things like Euroclear fees etc are still relatively steep?

    Comment by waratah — February 1, 2007 @ 2:50 pm

  2. Re the hedge q; Available size and also certainty of execution will warrant paying a wider spread in some cases

    Comment by holky — February 1, 2007 @ 5:23 pm

  3. True, but the size on these click & trade markets is rarely big.

    Comment by waratah — February 2, 2007 @ 12:20 pm

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