In the fixed income landscape, ‘liquidity is in the eye of the beholder’ as noted by one panellist when discussing how firms can best leverage trading toolkits and sell-side relationships to navigate evolving bond liquidity and market fragmentation.
Liquidity can mean several different things, the panellist explained. Depending on where you sit in the ecosystem various factors come into play when selecting liquidity and a provider, with cost playing a consistently crucial role.
“Liquidity has a cost whether we like it or not. It comes from the mismatch between two investors, timing and size – someone has to gain from the mismatch,” noted another panellist.
One panellist said that liquidity is about providing a reasonable price based on facts and not feelings. “What matters is not looking at a trade by its liquidity but instead, whether a provider is allowing you to trade effectively. A holistic approach is useful for buy-side,” they said.
Evolving sell-side
During the panel, the changing role of the traditional sell-side was discussed, with a particular focus on alternative providers’ increase in market share in fixed income.
Today, alternative liquidity providers have grown to compete with traditional providers as opposed to simply disrupting the landscape. It was noted by panellists that regardless of provider type, a holistic approach to providing liquidity is preferred.
Regulations such as Dodd Frank were noted as allowing new liquidity provider entrants to enter the free market.
Technology was also suggested by panellists as a key driver behind the proliferation of new entrants, as well as incentive, with alternative providers ultimately plugging into gaps left by traditional players.
“Incentives are divers for innovation,” said one panellist. “Looking where traditional banks left gaps is useful. It should be noted that starting from scratch is easier than banks using legacy technologies.”
The diversification of toolkits was also noted by a panellist as a driver behind the growth of alternative liquidity providers, particularly given the increasingly diverse instrument universe firms are looking to trade.
What traditional and alternative providers prioritise is ultimately different. Alternative liquidity providers – who are often more technologically focused – are often more focused on electronic smaller tickets flow for example.
As volumes increase across the spectrum, panellists argued that there is plenty of space for new liquidity providers as well as traditional ones.
“The differences are clear,” said one panellist. “It’s not about climbing rankings but bringing innovation into the market.”
Bonds ETFs
When exploring the liquidity landscape more generally, bond ETFs and the growth of this segment was also highlighted by panellists as being positive, with more sell-side said to be using ETFs alongside other tools to boost liquidity.
Alternative liquidity providers have been leading on the provision side. However, traditional banks are investing and getting more active in ETFs with increases in market share.
“Traditional branks are integrating ETFs with other parts of their capabilities,” highlighted one panellist. “We are seeing a diversification of ETF liquidity providers which is good ultimately.”
“ETFs shine during volatile instances. When underlying bond markets become difficult, ETF volumes surge, giving the ability to shift risk,” added one panellist.
ETFs are still a small percentage on bond markets, as noted by panellists. Holistically, the assets under management they cover is relatively small. However, panellists agreed that their usage could be key to boosting liquidity particularly in volatile periods.