A great session on selecting trading protocols at the Fixed Income Leaders Summit in Boston, allowed traders to consider what really say behind counterparty and protocol choices when setting up a trade.
Alexcia Mazahreh, senior fixed income trader, Vanguard, said, “I think every order needs to be evaluated on a set of given characteristics and nine out of ten of those trades, there’s going to be one way to trade and that choice is going to be data-driven, informing where to trade, what platform, with whom, and how many to show. All of that gives us the highest probability of success and best execution. Then, there is going to be one out of every 10 trades where there’s other things going on, and the trader’s discretion is needed – that’s the human touch.”
The improving access to data is fuelling greater automation in pre-trade decision making which is taking advantage of new technologies. “This is where you can train and use machine learning,” said Andy Chai, executive director, JP Morgan Private Bank. “If it looks like an ETF trade, I’m going to Jane Street, all day, because they’re better than the traditional broker dealers at that type of trade. If we look at 5000 line items and it’s the same account, it looks like a portfolio. So you can train the system to look for different characteristics. It’s even better if you take it even one step further. If ‘Bob’ can figure out how to how to route that and how to access that liquidity, whether it’s a US$10 million clip or if you chop it up into five pieces of US$2 million, that’s where you can use machine learning.”
However, despite the success in best pricing that non-dealer market makers are offering, there are other considerations that a buy-side firm has to be aware of, he observed. The level of trust around liquidity is impacted by having a dealer / client relationship, which does not exist for non-dealers, although he acknowledged that was lessening as dealer balance sheet shrank.
Nevertheless, dealers operate as more than market makers and that larger relationship has to be acknowledged. “It’s interesting because that’s going to impact your new issue allocation,” he said. “Dealers have a formula. If you rank 30 as the secondary counterpart at a given bank, they can only move you 15 spots up or down. If you’re terrible counterpart, you go 15 spots down, or if you are good, then 15 spots up, in terms of in terms of where they allocate new issue syndicate. Since that’s such a big part of the market, that’s another factor as well, and an unintended consequence in which you might be getting a better price and better liquidity at the non-traditional dealers but you’re losing in new issue allocations.”
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