US Treasuries trading transformed for buy side

Published on 11 June 2019

Buy-side traders are changing the way they execute US treasury trades, giving greater opportunity to capture alpha and to secure best price. New platforms are offering trading desks a greater choice of how to reach counterparties, better supporting best execution and low touch trading. Tim Cook, head of sales for EMEA & APAC at platform LiquidityEdge, which has captured around 10% of US Treasury trading since its launch, gives expert insight into how assets managers can take advantage of these trading models, both for alpha generating and hedging trades.

Dan Barnes Welcome to Trader TV Fixed Income – Your insight into the trading climate for professional bond investors. I’m Dan Barnes. US Treasuries are trading in the range of 2.2 to 2.9% at the moment, depending on their tenor, making them one of the few government bond markets offering a positive return. Trading these treasuries has changed dramatically over the past 10 years, challenging buy-side traders to deliver best execution for investors. We’re talking with Tim Cook, head of sales for APAC& EMEA, at trading venue, LiquidityEdge, to analyze how traders can better seize investment opportunities for investors. Tim, welcome to Trader TV.

Tim Cook Thank you.

Dan Barnes What are the risks that a buy-side trader is exposed to when trading US Treasuries?

Tim Cook When trading US Treasuries the buy-side has a couple of different factors, mostly that they have to consider. One of those is the immediacy of the trade, so in the traditional formats, an execution trade on the buy-side will be submitting either an RFQ or they’ll be speaking to their dealer with whom they have a relationship, and that whole process takes time. So, from the point perhaps of their interest in making the trade, to actually executing the trade, there could be a fair amount of market slippage. That price can be moving around. The other aspect which they are beholden to the market is market impact. Traditionally, an execution trader would state to maybe a handful of participants via RFQ, ‘well, this is the instrument I’m interested in, this is the size I want a price back in and perhaps this is my direction.’ And with that there is market impact that is being leaked into the market.

Dan Barnes How do you help traders manage those risks?

Tim Cook We make traders manage those risks really by providing what is essentially a streamed order book. We take the traders, and we say, ‘right, which liquidity providers do you want to be plugged into?’ And we will connect them to a range of different dealers in their order book. They are then seeing a whole list of executable price levels where they could sweep across multiple price providers. They can still maintain that relationship with the dealer, because essentially the dealer they are trading with has done their best to win the trade and they’ve won that trade on best price. So it really does make everyone a lot more accountable in this process. The D2D market really is made up mostly of on-the-run treasuries. The D2C market is made up of, let’s say, 60 to 70% of-the-run treasuries. The on-the-run markets operate as a very liquid product, almost in a currency in that sense. You have six issues which are very highly liquid and everything is very commoditized and homogenized around those six issues. With the off-the-runs, you have a tail of perhaps 300 securities, some of those, perhaps the 2nd to 3rd off-the-run, the 2nd to 3rd series, or let’s say the 1st to 3rd off-the-run series, are traded at a very narrow spread to where the on-the-runs trade. But the rest of that tail and going out the other +200 securities, they are by essence quite illiquid. And the price discovery isn’t there as much as it is in those newer series. And really what we try to do on our platform is to look at what are the most liquid parts of that market. And that’s where we see really the expansion of what’s happening in the D2D space, moving over to the D2C space as well.

Dan Barnes So is there a risk then that without that, there’s a sort of cliff edge of information in terms of going from on-the-run to off-the-run and you’re sort of turning that more in to a gradient?

Tim Cook Yeah, absolutely. I think that’s a well put point. I mean you find that the majority of the information is around the D2D market, and it definitely tails off somewhat towards, especially towards the deeper end of the off-the-run. So, I think what you’re finding is there was a lot more transparency and there’s a lot more comfortableness in being able to quote AT-type spread in, certainly in the newer off-the-run series.

Dan Barnes So sell-side firms are streaming prices to buy-side counterparties, upon which they can execute. How do you see buy-side execution styles changing as a result of that?

Tim Cook Yeah, it’s interesting. We’ve definitely seen a shift in the way that the buy-side firms will execute now. Maybe a few years ago we would have been the tier one, the tier two firms who were looking at kind of automated, smart-order routing, and the ability for them to execute via their own internal systems. And I think we’ve seen a proliferation of that and an extension of that to a wider demographic of buy-side participants. So, typically, or historically let’s say, the traders/the firm would take and look at the screen and point and click, there you go, trade executed. And the way it can be now is that essentially we will aggregate the liquidity, and we could push that into a buy-side firm who has an algorithmic strategy, that is working execution orders from the traders behind them. But also what is compounding and making that even more interesting is that the ability for firms to leave resting orders as well. And when you start to leave resting orders and you can layer on top some VWAPs and TWAPs, perhaps some other algos that are more firm-bespoke, it then becomes very interesting. So, the development has almost been, certainly at the sharper end, has been the fact that, they will take our liquidity, our package liquidity, and then they will plug that into their own execution capabilities, where it perhaps is a computer or black box that is generating the execution. And it’s really working behind the parameters that they define, not necessarily that of a manual trader sitting at a desk.

Dan Barnes And of course, treasuries are used in two ways. You can use them for generating alpha and also as a hedge for credit. Does that affect the way that people need to interact with the platform?

Tim Cook A lot of those guys, they will hedge with the 10-year, on-the-run Treasury or the first old 30-year. And that’s certainly something that we are looking to foster broader partnerships with, i.e. the ability to get those credit trading guys access to real-time liquidity. One of the key things is the control of the amount of information that is going out on both sides.

Dan Barnes And so there’s transparency around greater information, but not transparency in the sense that it creates more risk?

Tim Cook Correct. Yeah, exactly.

Dan Barnes Tim, thank you very much. Pleasure.

Tim Cook Thank you.

Dan Barnes I’d like to thank Tim Cook of Liquidity for his insights into the US Treasuries market, and of course you for watching. To catch our monthly reports on other markets, or to subscribe to our newsletter, go to TraderTV.NET.