Transparency can smell like information leakage by any other name, to butcher a Shakespeare quotation. Giving up information needs to happen at the latest point, and to the fewest people possible, on both sides of a trade. Clearly, however, that exchange has to happen somewhere in the middle of a transaction to prevent one side being hopelessly outgunned by the other, in an information arbitrage.
Credit traders, and fixed income traders more broadly, are subject to this dynamic more than most, due to the fragmented information picture they need to assemble ahead of agreeing to a trade.
The risk that transparency/information leakage creates for traders, is that if counterparties know a big position is being taken on, it will be expensive to get out of. The higher the cost to exit, the higher the cost to the client. Post-trade reporting into the market potentially increases that risk as the position is more visible.
A new report by Barclays Bank has found only 13% of buy-side respondents globally expect “enhanced transparency” to negatively affect block trades in fixed income. Twenty five percent expected better liquidity for blocks and tighter bid-ask spreads to be the result.
The 100+ traders that the bank spoke to for its research around the world will be sitting in a wide range of transparency regimes, so the most significant expected change to transparency – the incoming rules in the European Union and United Kingdom to develop consolidated tapes of bond prices – will only affect some of them.
However, the outcome seems net positive for the vast majority, even excluding the 12% who expect to build systematic investment strategies based on better data. Firms that can take advantage of more information to generate alpha will clearly see an upside.
While transparency has a cost in credit markets, like any cost it needs to be managed and factored into any downstream pricing. Trading out of a risk position has been greatly facilitated for dealers by electronic connectivity either directly with liquidity providing counterparts, or through platforms which allow a wider range of firms to provide liquidity to dealers. Services that take liquidity from a traditional interdealer pool and improve access for buy-side firms can seriously help the sell-side to optimise market making.
Higher volumes of smaller ticket trades create opportunities for positions to be reduced in a relatively short period of time and greater use of portfolio trading also facilitates the exiting of more illiquid positions.
While there are reasons to be careful about managing change, the bigger picture is that US markets, which have the most transparent post-trade bond regime, are easier to trade than European markets, buy-side traders tell us, but do not see the same levels of bid-ask spread compression found on the European side of the pond in credit markets.
Consequently, it is hard to argue that whatever the cost of transparency, it is clearly not so severe that it hurts market makers and liquidity access.
©Markets Media Europe 2024
