Rule-based credit trading and counterparty prediction tools

Published on 23 March 2021

In February corporate bond trading volumes were relatively quiet for KBC Asset Management, and the market more widely was low and patchy, with tighter spreads. Transaction costs were relatively unaffected from recent months but were two thirds the level of February 2020.

Joeri Wouters, senior fixed income trader at KBC AM, says his team were able to take advantage of the quieter markets to kick off three new projects including rule-based trading for Euro-denominated credit which delivered 85% automated trading which potentially could replace its use for all-to-all trading, plus a model-based counterparty prediction tool.

Dan Barnes Welcome to TRADER TV – your insights into trading for professional investors. I’m Dan Barnes. Joining me today is Joeri Wouters, who we would like to welcome back to the show, senior fixed income trader at KBC Asset Management. Joeri, welcome back.

Joeri Wouters Thanks for having me back.

Dan Barnes Can you tell us a bit about what you saw in February in terms of trading volumes and any volatility in the market place?

Joeri Wouters So February was a relatively speaking, quieter month on our desk with regards to credit trating. We heard in the market that general liquidity was low with some very low volume days. It was the kind of days you would expect in summer or December, and that liquidity was also quite patchy because absolute spread levels were still very tight. People were looking at the primary markets, but by the end of February it became more busy however, with insurance portfolios coming back into the market on the back of the rates volatility that we see.

Dan Barnes What central challenges did that create for your trading desk?

Joeri Wouters Transaction costs were in line with January and taking December out of the picture, also in line with the cost we observed from September to November 2020. However, we did see a significant difference with the transaction costs realized in February last year. On average, we transacted that two thirds of the transaction cost last month versus the same month one year ago. And then we went into March a little of course. Based on the excess we got in, we did see the banks being more aggressively looking to buy bonds at the beginning of February compared to the end of the month. By the end of February, we did see volumes still being skewed toward banks willing to buy, but based on the number of tickets, it was more or less balanced out.

Dan Barnes You can engage in a number of projects on the trading desk in terms of automation and all sorts of interesting uses of data in trading. Can you tell us what are you engaged in right now to deliver best execution for your investors?

Joeri Wouters Given the lighter volumes that passed by our desk in February, we were able to kick start three projects that we had been working on to add efficiency and liquidity. February was the first month in which we really rolled out rule-based trading for euro-denominated credit tickets. For this, we are cooperating with the same platform that we are using for automated trading on the rates side. We did start off with the smaller tickets, 500 gain below, and we are increasing the number of counterparties in competition slightly compared to our annual trade.

The selection we do is done on different criteria like screen prices, excess and other interests as well. And in order to maximize our chance of execution, we also allow for, fx, country. We did put a tight price tolerance to start of it just to be on the safe side. However, the first results were really, really good for us, around 85% of our orders got executed automatically. We are now looking at our data to improve the selection criteria further, and we would expect a rule-based credit rating to partially replace all-to-all as a means of execution for smaller tickets. But we think all-to-all will remain our main method for execution for the business, though.

Dan Barnes So you’re seeing use of lower touch trading as a potential replacement for all-to-all. Is that because all-to-all also takes the weight off your shoulders in terms of managing lower value trades?

Joeri Wouters Exactly. On our desk, the smaller tickets, everything, all-to-all is a viable way of quickly and with good results execute that kind of flow. But I do think the rule-based trading is a better thought through process than just sending your orders through to the whole market for everyone to see. I do believe that rule-based trading, putting less people in competition will over the longer term provide better execution for the clients.

We also rolled out our model-based, counterparty prediction tool that was developed in cooperation with the data scientists. This one we will now test in production during the next few months and see how we can improve it further. The way it works is we receive both a pricing probabilities corporate dealer as a dealer ranking for a given bond, and during the piloting we did see promising results whereby we could significantly decrease our average pass rate. Additionally, we did see a high proportion of winners in the top 10 brokers. The piloting did reveal, however, that the tool does not add significant value for a rates trading, but it is adding value for in EM. But we do expect the real value of the prediction model to come out in times of stress.

Dan Barnes I’ve seen some interesting discussions about the use of different trading protocols, such as portfolio trading on a bilateral basis and their platforms. Could you just tell us how you’re engaging with that as a trading protocol at the moment?

Joeri Wouters We did some new analysis into portfolio trading, but for now we do still favor the line by line execution methodology over portfolio trading for our type of business at least, and certainly for harder-to-trade baskets. We are keeping a close eye on the developments happening on the pre-trade side.

Dan Barnes Joeri, thank you so much for coming back on.

Joeri Wouters Thank you for having me.

Dan Barnes I’d like to thank Joeri for his insights today and of course, you for watching. Catch our other episodes or to subscribe to our newsletter, go to TRADERTV.NET.