The idea of electronic dealer to client (D2C) trading in repo markets is well accepted in concept but gaining client confidence to make the switch from phone or emails can be much harder. This article sizes up the main obstacles to D2C adoption, our market observations and viable solutions. A guest post from MTS Markets.
In a perfect world, all repo transactions would be electronic with Straight-through Processing (STP). Back office staff would not have to intervene in a settlement unless there was a clear and obvious issue, in which case the same technology platform that executed the trade could be used to audit the transaction and find the problem. This seamless idyll would support downstream data integration to both CCPs and back office systems, feeding repo exposures to risk and liquidity systems, not to mention supporting pre- and post-trade analytics.
Most repo professionals will be squinting by now. The idyll does not yet exist although perhaps it might in the future. The reality today is that while the technology exists for electronic repo in a bustling market, both dealers and clients continue to be reluctant to fully commit. We find that the causes of hesitation are more behavior-driven than based on technology. This suggests that working with clients on their business concerns could result in an expansion of the electronic D2C market for both dealers and clients, with attendant benefits for all firms.
What clients say
Client concerns about moving to electronic repo trading and STP come in three main categories: liquidity, pricing and relationships.
On liquidity, some clients feel that their dealers will not be sufficiently engaged in electronic platforms. This can lead to a chicken and egg problem: dealers may want to wait to sign until their clients onboard, but clients want to know that their dealers will be there. So far, some large clients have been able to encourage their dealers to engage, but not all clients have that sort of leverage.
On pricing, clients wonder if dealer costs will be passed on in the rates they are quoted, leading to an increased cost of funding. This is closely tied to the idea that relationships matter in repo. There is some fear that electronic repo could cause a reduction in the value of the relationship that would in turn result in worse pricing, or potentially in loss of access to dealer balance sheet.
What we see in practice
On all three points, we see that the concerns of clients are generally unfounded, and that the reality looks far better for both dealers and clients. Dealers that have readily adopted electronic repo now report that they put their best liquidity and pricing on these systems, recognizing that full STP and no settlement breaks is better for the bottom line, and they encourage their clients to move in that direction. This is not to say that electronic repo solves all ills: in fact, we do still see evidence of dealers who are not fully invested in electronic repo preferring to continue to price and book trades using more traditional methods. As this group of dealers shrinks, and those embracing the new technology grows, we see it becoming an increasingly important metric that clients use in their dealer selection.
Operationally, the need for electronic repo can be more critical at firms with hundreds of small transactions a day; this is where automation has the most obvious benefit. Meanwhile, firms with just a few large trades a day may see less incentive to automate and have less justification to make new tech investments. Regardless, uptake from all sorts of clients, from asset managers to central banks to hedge funds continues to grow as firms realise there are tailored solutions that can work for them.
Across the industry we have found that worries about a loss of relationship when moving to electronic repo have not held up in practice. Instead, both clients and dealers report that relationships are stronger when the conversation moves away from “is my GC ticket done” to “let’s discuss the next important strategic initiative.” Additionally, whilst the D2C electronic repo market is still in a relatively young state, the proportion of pre-agreed “processed trades” to competitively, electronically negotiated trades remains high. Both clients and dealers are looking for efficiency; the opportunity to stop talking about low value trades and look to enhance the quality of the relationship is a net positive for everyone. The ability to be a better client to a dealer may wind up being the biggest benefit to electronic repo.
The MTS approach to creating a successful outcome
We recognize that behavioral concerns about liquidity, pricing and relationships are central to the hesitation of many firms to embrace electronic repo trading. MTS has responded by developing a technology and business strategy that maximizes these three areas for both dealers and clients on our platform. This starts with providing dealers flexible tools to stream their inventory to their clients, based on their quotes in our established interdealer market. Dealers are not required to trade on two different platforms, but rather can interact with clients using the same technology that they have been using for years to transact with other dealers. The ability to share the same inventory and axes in both the dealer and client market simultaneously deepens the liquidity pool and improves pricing opportunities for clients. Clients are no longer constrained to a corner of the repo market, but rather can get connectivity and data from the interdealer market as well.
Clients also benefit from an end of day repo data bulletin that provide valuable transparency to help them make their trading decisions. This MTS daily bulletin provides an aggregate view of the daily trading activity in our interdealer market showing the weighted average rate and aggregate volume for every combination of security and term including GC baskets, specials and triparty. Although concerns about liquidity and pricing may linger, having the data to prove the reality and advance a client’s own investment strategies can make an impactful statement.
While we have made advances in other areas as well, in particular onboarding and working towards standardization, we find that these are smaller obstacles than helping clients work through their less technology-driven concerns. As more clients recognize that electronic repo supports rather than hinders liquidity, pricing and relationships with dealers, we expect further expansion of a business model that supports the growth of the entire industry.
About the Author
Tim Martins is Head of Product for Repo and Money Markets, MTS. Tim has over 20 years’ experience in repo, including 11 years on the trading desk at Bank of America. During his six years at MTS, Tim has overseen the development and launch of MTS’s BondVision Repo dealer to client repo trading venue.