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RFQ, RIP?

At TradingScreen(TS) we are not afraid of admitting when we set out to solve one problem and subsequently solve another much larger and completely different one.

Ever since the 1990s, RFQ has been the dominant trading protocol for Fixed Income. It replaced the four phone calls a buy-side had to make to get a trade done. Calls to three individual dealers for the competitive prices, then a fourth to the best one to do the trade. Hoping of course that by the time the fourth was made the market had not moved and the whole process had to be conducted again. What was especially annoying for dealers was, that process was identical for 10k or 10 million.

It now sounds ridiculous, but electronic RFQ in Bloomberg was a minor revolution in FI trading protocols. It remains how most trades get done today across various venues. Although it can, of course, be enhanced through auto-execution protocols, the principle remains the same, ask multiple dealers and take the best price.

RFQ is, by its’ very nature, kinetic, public and not ideal for the winning dealer. Hence it works best for smaller orders and is less relevant for larger orders or very illiquid issues. This, to some extent, explains why electronic trading volume growth is struggling to maintain a growth path commensurate with the growth of the overall market. It still only accounts for 35% of US Corporate bond volumes, compared to say 95% of Listed Equity volumes.

There is a huge cost, time and efficiency problem to solve here. Not only that but whoever solves it and uses the solution will have a simply colossal and legal advantage over anyone else. A bit like comparing a 5G smartphone to a 2G Nokia. 

We were responding to a request from a Buy-side customer to integrate Dealer price streams into the EMS to assist with their pre and post-trade execution business intelligence. What happened was the TS developers came back with a liquidity book of Dealer price streams, or actionable axes and IOIs all in one window. They called it Liquidity Plus.

The prices and axes were ordered by price/spread and size with the identity of each Dealer or venue alongside. A clickable buy, sell or engage button appeared to be about as far as we could take this idea. 

If you thought the TS developers stopped there however, I am about to disappoint you. They then included the pre-trade benchmark price/spread execution feed to enable the Buy-side trader to immediately see which orders had actionable liquidity inside the benchmark feed. 

They then added an auto-sweep function to enable the buy-side trader to understand immediately from the order management window, how much of each order could be executed with the available liquidity. In each case, the execution protocol is a direct Buy-side to price/spread Dealer interaction. There is absolutely no multi-dealer RFQ workflow insight. Each Dealer price/spread and size is executed D2C privately. The Buy-side trader understands the execution performance analysis pre-trade because of the benchmark feed and all the Dealer and venue data in Liquidity Plus.   

Remarkably this protocol suits both the Buy-side trader and the Dealer. The “in-flight” liquidity automation of every Buy-side order is also a huge time saver for busy Buy-side traders with multiple orders to execute. It shows the Buy-side trader an “at a glance” and real-time analysis of every order in his TradeSmart EMS. It even records this for post-trade analysis. The Dealer streams precise liquidity to Buy-side TradeSmart users only, knowing there is absolutely no data leakage. Every inquiry received is about a specific axe or price and nothing else, so no time-wasting distractions. 

Surprisingly though our analysis indicated that both buy-side traders and dealers can now execute orders with zero market impact risk, large ones as well. That has to be the biggest evolutionary step forwards in Fixed Income market structure since the introduction of electronic multi-dealer RFQ. Large size electronic execution with bestex, but no market impact where both Buy-sides and Dealers are satisfied.

The next phase is to allow the Buy-side to “work-up” more size with the Dealer, much as happens now in the Inter-Dealer environment. This will further increase the impact of electronically finessing large Fixed Income orders.

Our analysis also showed us that the real-time liquidity updates can now be used as an “execution timing” indicator. So, as well as showing “matching” liquidity for any Buy-side order, the liquidity window also shows “same-sided” liquidity as well. This now helps the Buy-side trader avoid entering a well bid market with a buy order and vice versa. Again, dramatically helping the Buy-side trader to finesse execution. This feature has also become a valuable tool for Buy-side PMs and strategy analysts. In other words, they can now see if a particular issue is well bid. The TradeSmart EMS also shows similar issues where there is better, matching liquidity. 

We then discovered this execution process can be automated. Parameters can be set for benchmark divergence and Liquidity Plus swept accordingly. This type of advanced pre-trade business intelligence has provided an intelligent alternative to multi-dealer RFQ for TradeSmart users. It has also significantly empowered both the Buy-side and Dealer traders in executing large orders electronically.  

Remember, this only works if the Buy-side trader uses TradeSmart FI EMS. Dealers know this, which is why they are turning to TS to better serve their Buy-side clients on terms that suit both sides. Dealers know that Buy-side firms stage billions of actionable liquidity into TradeSmart every day. Interacting with that liquidity in such an efficient and discreet way is the key to much larger electronic volumes.

This new protocol could finally be what moves the needle for electronic Fixed Income volumes to Listed Equity levels.

Finally, back to the beginning of RFQ, when it’s main purpose was to prove “best execution”. The liquidity book performs this function constantly in real-time by showing the buy-side trader where the best execution opportunity is for the unique order on the blotter. It means there is no need to go anywhere else and the EMS captures the surrounding price data in the post-trade execution record.

When there is insufficient liquidity data in Liquidity Plus a Buy-side trader can also see historic traded volumes, RFQs, and axes in that bond or other bonds from that issuer.

In summary, a TradeSmart buy-side trader can now look at live orders staged into TradeSmart EMS and see an immediate and real-time, individual, consolidated pre-trade analysis of all orders that can be executed at or better than the benchmark price/spread feed. 

  • Paul Reynolds

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