European fixed-income: the MTS story
Fixed-income markets across Europe have undergone significant evolution in the past twenty years. When Mercato dei Titoli di Stato (MTS) was founded in 1988, it represented the first step in a large scale transformation of the secondary market for European government debt. Desire from the Italian Treasury to make sure the debt it issued was quoted in a centralised, electronic and transparent (and thus easy-to-monitor) environment was the driving force behind its launch, and other European governments soon followed suit Since its privatisation in 1997, MTS Group’s European exchanges have grown to represent a continent-wide facility for the secondary market in the public debt of fifteen countries, and today over €2 trillion worth of trading activity takes place on the Group’s cash markets each year.
This fundamental change in the way government fixed-income assets are traded has led to bond trading now being broadly conducted by one of two methods. This is often described as a division between ‘on-exchange’ and over-the-counter (OTC) trading, but this distinction may perhaps be unclear.
The real distinction, the distinction that has defined and continues to define the evolution of fixed-income trading in Europe, is the division between electronic trading and voice trading. The question underlying the future of bond markets is whether trading activity will continue to move towards centralised electronic facilities like MTS or, as has been seen to a certain degree with the volatility of the last two years, whether traders will revert to doing business directly between themselves.
There is still a strong rationale for promoting an electronic secondary market in government debt securities. For governments engaged in large, frequent debt issuance, it makes sense for trading to be encouraged on a regulated, centralised, electronic and liquid secondary market. Primary dealers of government bonds are assigned specific roles so the issuers can monitor their activity. Participation is encouraged with incentives for primary dealers: treasuries still reward dealers for putting order flow through electronic exchanges. As a result, a majority of the government bond price discovery process takes place electronically.
Market volatility in 2008 led to a short-term widening of bid/offer spreads, however, which in turn led to a noticeable (but not substantial) move back to voice trading of government bonds. It is still likely however, that the mid to long term future of bond trading will see government debt continuing to be traded electronically in greater proportions. Increasing volumes on MTS’s cash markets point to this. There was an 88 per cent rise in the total value of trades across the Group in 2009.
In terms of trading in smaller, more complex and non-government fixed- income instruments, the future will depend greatly on regulatory reactions to the perceived danger of packaged debt. Much has been made of the need to centrally clear a swathe of instrument types, but whether that will extend to making it obligatory to trade, or at least quote, certain products on regulated electronic exchanges is yet to be seen. Supposing intervention does not take place, it is difficult to see a short-term future where trading in such instruments will become significantly more electronic, because they are more niche, less liquid, and do not necessarily attract incentives from issuers.
For MTS Group and its clients, today’s secondary bond market is significantly different to that of 1988, and it continues to change at a rapid pace. The full effects of the explosion in government debt issuance have perhaps yet to filter through fully to the secondary market. The effect so far has been mixed for the expansion and evolution of bond markets. First, there is obviously more issue inventory available for trading. This is good news for banks, of course, as it has brought them increased business flow. On the other hand, surges in sovereign debt levels, and economic difficulties in centres such as Greece and Dubai, have raised questions about governments’ creditworthiness. While the evolution of bond markets in coming years may hold surprises, it is certain that bonds, and a liquid secondary market where the price discovery process is transparent to all interested parties, will remain vital for the funding of national governments.
About Jack Jeffery
2008 – present, SuperDerivatives
2006 ICAP Electronic Broking
CEO of ICAP Electronic Broking, including Brokertec and EBS
1990 - 2001 Citigroup
Global and European Head of FX Options since 1999
1984 - 1990, Midland Montague
Director of Treasury Midland Montague (Australia) since 1988
1982 - 1984, BNP Australia