Summer has revealed interesting trends underpinning electronic rates trading volumes

Published on 28 August 2020

Electronic trading in the rates space has been growing across the US and Europe, but has declined over summer in US Treasuries.

Ken Monahan, vice president for Market Structure and Technology at analyst firm Greenwich Associates, gives us an insight into what is driving the proportional increase in dealer-to-client (D2C) electronic trading in 2020, in contrast to the overall trend, and an understanding of the importance of futures trading as a counterpart to the cash bonds market.

Dan Barnes Welcome to try to Trader TV, I’m Dan Barnes. Joining me today is Ken Monahan, vice president for Market Structure and Technology at Greenwich Associates. We’re going to be talking about the rights markets, specifically electronic trading in the US treasuries market and the European government bond markets. Ken, welcome to Trader TV.

Ken Monahan Thanks for having me.

Dan Barnes So tell us how are US treasury markets looking at the moment, relative to previous months and also previous August?

Ken Monahan August is historically kind of a slow month. Interestingly, July was so slow that this month is actually a slight uptick from last. It’s about in line with previous August, which is a little surprising considering about, you know, there are very large…. And of course, also Powell spoke this morning, so who knows what the answer to this will be tomorrow. Kind of a major shift in Fed policy today. But, yeah, it’s kind of in line with previous August. The structure of the Treasury issuance, the structure of the Treasury market and the way in which different parts of it interact; these are all significantly different than they were, but in terms of overall volume levels, it’s not too distinct.

Dan Barnes And then how has e-trading been as a proportion of the market relative to voice and also within different segments, so D2C and D2D?

Ken Monahan During the acute phase of the COVID-19 crisis back in in late February, early March, we actually saw a decline in e-trading. But what we found across the Treasury platform space is that the levels of e-trading have increased since then. E-trading as a proportion overall has sort of returned to the normal trajectory. What’s interesting is the is the mix of that. And one of the difficulties is sort of a lot of the single dealer platforms, a lot of the sort of direct streams from the dealers to their clients are not reported on. If you saw there was a report out from JP Morgan that said there was a lot of uptake from their clients of direct streams in recent weeks, and that’s very interesting. I think the reliance of customers on electronic trading that is increasing. The most interesting thing is that the inter-dealer markets and also the futures markets have actually declined a bit in their volumes. So I don’t know if this is widely known, but historically, futures markets have been about the same size as the cash markets in US treasuries, and this is not the case at almost any other asset class. So, in FX, futures are a relatively small proportion of the cash markets. But in treasuries, the futures market and again, the futures market is organized on a central in the order book, which is a much different protocol than the vast majority of dealer-to-client trading is done in cash treasuries.  Interestingly, the central in order books for cash treasuries for the dealer source their own liquidity: a lot of the liquidity in that market is the result of arbitrage between the cash and the futures markets. Arbitrage relies on a number of things; one of which is the margins required at the futures exchange. Another is the cash futures basis, which is funded in repo markets. And what happened in the acute phase during the period when there was this massive rush for cash on the part of corporates around the world looking to shore up their balance sheets to ride out the COVID-19 work stoppages, was that repo markets got extremely tight.  And it actually had the effect of breaking or making very difficult the execution of that arbitrage trade that linked to the cash in the futures. And then also because there were these giant moves, the futures exchanges raise their margin requirements because, of course, the variance of the asset had spiked. And of course, it takes a while for those data points to fall out of the sample and for the margins to return to normal. That trade is usually levered quite a lot, and so when you have a bunch of outlier events, your willingness to lever that trade goes away. And so there’s a weakened link between the cash in the futures markets and that’s sort of what you see when you see the reduced volumes in the central limit order books and cash. The cost of financing the trade, the reliability of the trade, the amount of leverage in the trade; all those things have changed as a result of actual full-on market activity, and that’s persistent.

Dan Barnes Do you have a view on how much e-trading is going on in the non-government bond markets right now and whether that’s increasing or declining?

Ken Monahan I think it’s generally increasing and there’s a lot of interesting stories there, so the LSEG-Refinitiv merger has a number of implications for that and that’s a big story. The fact they’re going to probably divest Borsa Italiana because it controls MTS. The way the European rates markets are structured is quite different. First of all, there isn’t really a substitute, there’s no parallel for the Treasury market; It’s the risk free asset in the world’s reserve currency. It has a lot of features that are not present elsewhere. In Europe you have a very interesting feature where all of the governments are different and the credit ratings of those sovereigns vary quite widely. And no single market is that large. The interesting thing about Europe is how big the futures markets are relative to the cash. So there the bund futures market, sort of performs the function of the Treasury market and to some extent, the function of the Eurodollar futures market in the U.S. as a sort of rates hedging. So they are, in the cash bonds, you don’t see as much electronification pr. se, but that’s masked to a large degree by the fact that the bund futures markets, which are electronic, trade vastly more than any individual sovereign bond market within Europe. I think the European governments would like to see an increase in electronic trading; they like the efficiency of it. And I think the fact that you’re going to have persistent competition between Tradeweb, Bloomberg and MTS, that will probably push innovation over there. But it’s always important to remember the bund futures market when thinking about European rates electronification.

Dan Barnes Ken, thanks very much.

Ken Monahan My pleasure. Thanks for having me.

Dan Barnes I’d like to thank Ken for his insights today and of course you are watching. To catch up on our other shows is go to TraderTV.NET or ETFTV.NET.