Technology, Efficiency and the Rise of Liquidity Outsourcing in Fixed Income
Some excerpts -
- "The market shift mirrors a transformation that began more than 25 years ago in the FX market. In FX, dealers adopted trading technology capable of pricing, managing credit, assessing inventory, calculating risk, and automating the booking of large volumes of RFQs. The Fixed Income market is now following a similar trajectory, although the journey has been delayed due to more intricate workflows and the diversity of asset structures across rates, credit, IRS, CDS, MBS, Munis and other products."
- "Modern technology can now automate even highly complex Fixed Income workflows. Advanced pricing engines, real-time analytics, integrated order and execution management, and automated booking systems allow dealers to service clients more effectively and scale their operations. The central question for many institutions, however, is whether the investment required to build such systems is justified. Is the resulting revenue meaningful? Can it scale? Or are these edge cases relevant only to the largest dealers?
Historically, banks faced a binary choice. Either invest in automation or risk losing client business to more advanced competitors. However, a third option has emerged."
- "Liquidity outsourcing—sometimes referred to as Trading as a Service—enables a bank to leverage an external Liquidity Provider (LP) for pricing and execution. Under this model, an LP provides liquidity via fully automated trading software to support the bank’s client pricing across multiple assets. The LP’s liquidity supplements the bank’s trading desk, while the technology supports efficient workflow execution.
This model is flexible. An LP may provide liquidity in credit bonds, U.S. Treasuries, Euro Govvies or even during specific hours, such as overnight, when some mid-tier banks do not staff trading desks. The rationale behind liquidity outsourcing is that it provides benefits to the LP, the bank and the client. The LP benefits from an increase in its trading flow without having to onboard new individual clients or resource regional sales offices. The intermediary bank services its clients with Tier 1 pricing and wider asset class coverage, without the cost of capital and the cost of running a trading book, potentially taking margin. The end client can efficiently trade with its preferred local bank as a one stop shop across all Fixed Income products. A win, win, win.
But why would any bank put its client franchise at risk by working with an LP in this way? The answer is that all client names are kept confidential, as the client deals with the bank, and the bank does a back-to-back trade with the LP.
Liquidity outsourcing initially catered to regional banks with limited coverage. Today, however, as market understanding improves and return on capital is under the spotlight for all trading books, some mid to large banks are increasingly exploring the model to supplement non-core liquidity in an optimal way.
Looking again at the FX market, liquidity outsourcing has been in operation for over 20 years. An early public example from 2004 was HSBC providing its FX platform and liquidity to subsidiary HSBC Trinkaus and Burkhardt, for trading and processing on a partial or exclusive basis depending on currencies and the time of day. Trinkaus managed the technology and maintained its own FX desk, relying on HSBC trading desks in London, New York and Hong Kong to price non-European currencies and trading support after the German desk closed."
The article is free to read at The Desk - https://www.fi-desk.com/transf...