Many of you will have heard the phrase request for market (RFM) uttered as of late. The protocol has reared its head in many different circles, and with good reason. It’s growing at an astronomical rate according to the platform providers.
For those of you that haven’t heard of it, RFM is a not-so-distant cousin of the request for quote protocol (RFQ). RFQ has cemented itself as a central method of execution in fixed income in recent years in light of the advent of electronic trading and the move away from bilateral voice trading and onto platforms.
RFM is a similar concept, also derived from a desire from investors to access as much available liquidity as possible to ensure order fills and achieve best execution. It too is a trading protocol used by traders to gauge interest from several dealers in the market at a time to achieve efficient execution of an instrument.
However, the key difference with RFM is that when using the protocol, a firm will ask for both the pay and receive price for an instrument. The bottom line being that it reduces market impact by showing two-way interest in a chosen instrument to hide a firm’s direction.
“As buy-side traders seek liquidity in larger size trades, the challenge to retain as much information as possible – while at the same time obtaining an executable price – can be difficult to navigate,” State Street Global Advisors’ head of fixed income trading, Sharon Ruffles, tells The TRADE. “As the fixed income market moves towards ever more electronification, RFM allows for price discovery with less information slippage.”
The two-way workflow is no new phenomenon to trading and is used in the execution of several other asset classes. Given the importance of market impact in fixed income, it therefore makes sense that the RFM protocol has seen a rise in popularity in the last year, particularly in the swaps markets, as a natural progression of the market alongside increased electronification. While not everybody is using it, it is growing.
As traders have increasingly begun to adopt algorithms in their execution workflows in fixed income, which are data hungry and protocol agnostic, this too has boosted the use of RFM.
According to fixed income platform provider Tradeweb, the trading protocol has grown from 19% in Q4 2022 in net risk terms, up to 34% in Q4 of last year. Looking specifically at G3 currencies [Euro, Dollar, Sterling] in the rates market, that growth story from 2022 to 2023 was from 17% to 32% – more than doubling in a year.
“Our functionality relies on dealer support for the liquidity to happen on the platform and dealer support really started to grow at the end of 2019,” Tradeweb’s head of European interest rate derivatives, Angus McDiarmid tells The TRADE. “It’s a growing interest for us on the euro government bond side. Whereas the government bond business has historically been very much an RFQ market.”
Market impact
When exploring why demand for this not-so-new protocol to the fixed income scene has soared in recent years, the same phrase is brought up every time: it reduces market impact.
“RFM was worth pushing for a larger in size trade to limit impact and limit dealers from being able to skew price based on knowing their direction,” explains McDiarmid.
Reducing market impact is central to the growth of RFM. One key client user group of the protocol is the hedge fund segment, and it goes without saying that hedge funds are some of the most impact conscious firms out there.
Many of these firms opt for two-way pricing to shroud their market direction and recent regulatory changes have driven a chunk of hedge fund flow that might’ve taken place bilaterally, on-platform. For example, thanks to Mifid and the push to broaden the scope of what should take place on venue, Sonia and Sofr swaps flow that might’ve previously taken place bilaterally now takes place on venue.
Tradeweb subsequently rolled out trading protocols for clients to engage with the Sofr alternative benchmark for US dollar derivatives and €STR for euro derivatives. Traders can use request for quote or request for market protocols and can upload Ibor portfolios into Tradeweb’s list trading mechanism for conversion into risk free rates.
Elsewhere, in emerging markets, where liquidity is thinner and any kind of inclination to trade is likely to be preyed upon, traders here have also typically favoured a two-way model both using voice and now, electronically. The result: a boom in RFM. At Tradeweb, around 67-68% of volume on its emerging markets platform was accounted for by RFM in Q4 of last year.
“For dealers it very much replicates an existing voice workflow that they have been doing nigh on decades,” Tradeweb’s global chief operations officer for emerging markets, Will Tarr, tells The TRADE.
“That ability to conceal the direction you’re trading pre-trade and then only reveal it to a couple of participants post-trade gives clients a much greater degree of comfort trading that electronically.”
Tradeweb and the London Stock Exchange Group’s (LSEG) FXall launched a new FX swap workflow solution for local currency emerging markets in August last year. The solution links trading workflows in local currency EM bonds and FX swaps through a single user interface (UI). Using the solution, mutual clients of the pair can buy or sell an emerging markets bond via Tradeweb’s RFQ or RFM protocols.
Tradeweb is now working on building out its RFM offering in emerging cash markets in local currencies.
Using an RFM protocol also contributes, Tarr confirms, to better calculation of the mid-price in emerging markets trading rather than look at a static curve. Something that also translates into the rates space as well.
“When you’re asking for one side of that PV [present value] market, you have to calculate how much you’re being charged, what’s the real mid, is the trade PV accurate? It might be in an area of the curve where there’s not a lot of liquidity and granularity and you want to look at a truer TCA,” explains McDiarmid.
“It’s much easier to do that when you put two or three dealers in competition and it makes it much cleaner to assess the real mid of that trade at that time for that size of trade when you have two-way pricing.”
All of this points to RFM as a natural next step in the development of electronic workflows in fixed income. Dealers are becoming increasingly confident quoting two way on platform, McDiarmid confirms, and some of this is driven by transferable behaviour from trading in other asset classes.
“They can still show an axe and skew that price to a direction they want to trade but they’re showing an honest two way at time of execution for that specific size. I’m happy to pay here and I’m happy to receive that,” he says.
“A really good example of that [transferable behaviour] is where we trade swaps versus bonds in non-contingent asset swaps. Clients have questioned, understandably, why they can ask for a two-way price on the swap leg and have to show their direction on the bond leg? It’s about that consistency.”
Rates vs credit
However, when looking at other potential use cases for the RFM protocol, there remains some areas whereby alerting several dealers of your interest – using two-way pricing or not – could prove to be harmful for the buy-side. While the RFM protocol is having an undeniable rise to fame in the rates space, whether it will see the same adoption in credit is another story all together.
Read more – Tradeweb and LSEG’s FXall launch new emerging markets FX swap workflow solution
Many have suggested that the natural next step, following this sudden interest from the street in rates, is for RFM to expand further into other corners of the fixed income sphere, creeping into credit when used correctly. Here is where the use cases of the protocol and its usefulness in reducing market impact become more difficult to justify.
“There is absolutely a place for RFM in fixed income, particularly in local markets, but I think it must be considered carefully what the best execution method is for a particular bond as often the market dynamics or inventory and liquidity of the line don’t result in RFM being the optimal protocol to use,” explains head of European FICC trading Manulife Investment Management, Peter Welsby.
In some markets, regardless of whether or not you’re showing a two-way direction, thanks to the liquidity landscape, it becomes easy to work out a firm’s intentions. This renders a protocol like RFM potentially harmful to execution in some cases. And, makes it extremely important to pick and choose when you use protocols.
“Whilst in smaller sizes it might not make much of a difference, for larger-sized credit trades quoting a multitude of banks, using RFM is likely to worsen the pricing received,” Welsby explains.
“The client may think that they’ve hidden their direction, but often in credit it can be quite predictable which direction the client is. As such, rather than using RFQ with select liquidity providers with strong relationships and market presence to minimise information leakage, the client has shown their full size to a whole host of dealers. This could negatively impact the winner of the trade and evidently won’t result in better pricing in the long run.”
Given inventory restrictions in credit, it’s often more challenging for a broker/bank to make a two-way price if they don’t have the bond to begin with. In credit, it’s also harder to source bonds from smaller issuances than in the local markets and because of that dealers are more reluctant to reveal their hand without a strong relationship with the buy-side client.
“We would consider using the RFM protocol for trades that are normal market size and where the market is deep and liquid,” adds Ruffles. “Market makers will be less sensitive to the direction of the trade and potential for information slippage, and so they are likely to be more comfortable making a tight two-way price.”
RFM has seen a rapid rise in demand in the rates markets in recent months. And this shows no signs of abating given the expected central bank activity throughout the course of this year and the predicted movement in the money markets.
While some macroeconomic factors such as reduced central bank balance sheet could cause a reduction in liquidity that could see a move toward more bilateral trading to protect market impact, RFM is undoubtedly set to continue to grow.
Whether or not it ever becomes applicable to more inventory-driven markets is another question with a less positive answer.