Thapelo Tsheole
Deputy - CEO
11 Sep 2014
Building Electronic Bond Markets &
The Role of Exchanges in Bond Markets
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1. What are e-bond markets and the forms
2. Evolution of e- bond markets
3. Pre-requisites for e-bond markets
4. Evolution of e-bond markets
5. Arguments for e-bond markets
6. Challenges facing e-trading of bonds
7. Pros and Cons of e-bond bond markets
8. The role of Exchanges in e-bond markets
9. Botswana’s migration to automation
10. Key considerations and success factors
11. Conclusion
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• The contention of this paper is that the advent of e-trading may be slow, but indications are that
the evolution to e-trading could present far-reaching benefits for bond markets
• Especially given the regulatory reforms following the financial crisis and the increased pressure
on dealers/banks to minimize inventory levels
• The paradigm shift from the inventory-driven model, pre-crisis, due to regulation such as Basel
III mandates a refreshed set of skills and technological infrastructure consistent with a “capital-
light” world
• The proliferation of several e-trading platforms has thrived on the need to promote
interconnectedness in the market but has also resulted in fragmentation of the market
• The forms of such platforms, the evolution, pre-requisites, advantages of migrating to e-markets,
the role of the stock exchange and the key success factors in this transition are discussed in
this session
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• Quotes from the buy side
• Predominantly dealer-to-dealer (D2D) trading
• And not customer –to-customer (C2C) trading
Multi-Dealer RFQ
Platform
• Matches orders off exchange
• Without first routing it to any public market
• Provides anonymity and low cost Crossing Systems
• Fully transparent, real-time, anonymous and low cost in execution • C2C & D2D direct trading • Customers can make markets themselves
Central Limit
Order Book (CLOB)
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The emulation of the equities-style e-trading platforms in bond market is faced with several
challenges that have to be addressed:
1. Dealers
Align the organization
Centralize the trading infrastructure
Harness the data opportunity
Transform the sales force
Reduce cost per trade
2. Institutional Investors
Would have to collectively change their behavior in several ways
Such as providing firm tradable quotes in the system
Investors who trade small lots could potentially increase trade frequency
Need to diversify their pool of investment strategies to support 2-way markets
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3. Issuers
Need to standardize their products
Match-based e-trading requires a high degree of standardization
But the cost implications of standardization have to be reasonable – should be a gradual
effort
4. Regulators
Regulation can ultimately break the bottleneck
If the current reforms are an impediment in the bond market
E.g. Basel III capital requirements
Regulators need to incentivize creation of market-making and defragmentation
And also need to optimize listing use by creating user-friendly requirements, and promoting
surveillance to instill confidence in e-trading platforms
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5. Infrastructure:
• that provides a conducive environment for securities transactions
• ensures legal title to securities and settlement of transactions
• and provides price discovery information and pre & post trade information
6. Product Type and Availability
• high penetration in plain vanilla debt versus structured products
• broader maturity spectrums – a good mix of short, medium and long term debt
7. Parameters for success
• involvement of the central bank in migration of gov’t securities to the Exchange's e-platform
• soundness of the banking sector in supporting cash settlement
• 100% dematerialization of bonds and centralized depository
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Source: Celent
Page 9
Source: McKinsey & Company (2013)
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Source: Celent
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• Hybrid trading system comprising OTC and ATS
• Treasury bills will also trade OTC
• Mobile phones used primarily for retail distribution of government bonds
• Automated Trading System implemented in 2012
• Bond trading in the ATS not commissioned
• Government bonds trade OTC
• Trades reported to the BSE – at EOD
• Bonds are traded in the Inter-Dealer-Broker OTC system
• JSE operates the Nutron trade reporting system for trade reporting, booking and
trade matching
• All trades reported within 30mins
• Hybrid trading system comprising OTC and ATS
• Brokers permitted to match orders off the ATS
• Trades are then reported to LuSE
• Unmatched orders are loaded into the ATS
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• By far the most transparent in SSA
• PD system maintained to promote liquidity – underwriting and market making
• ATS eliminates concerns about price distortion, price discovery and
post information dissemination
• Inefficient price discovery and opaqueness
• Unsystematic pricing – with varying conventions and formulae
• Untradeable quotes and late trade reporting
• Poor price discovery
• By far the deepest and broadest – but highly opaque
• Greater reliance of IDBs and greater confidentiality
• Trades only visible post execution
• High potential for market manipulation – a difficult market to survey
• Pre trade information inhibited by the OTC setup
• ATS usage is sub-optimal as brokers can pre-match orders manually
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Efficient market controls
Fairer Competition
Cost Reduction & Improving Efficiencies
Pre & Post -Trade Transparency
Promotes Quality of Liquidity
Greater Market Depth &
Less Fragmentation
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Stricter capital requirements
Lack of product standardization
Requires coordinated effort
Challenges presented by
unregular liquidity
Fragmentation hampers
standardization
Regulatory shift feared to add
another cost layer
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Leading U.S.
corporate bond
e-trading
Leading U.S.
Treasury trading
Has the largest market
share across Europe
and Asia
Developed In-house
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Country Trading System
Botswana Millennium IT ATS
Egypt OMX X-stream
Ghana Ghana Automated Trading System (GATS)
Kenya Millennium IT, moving onto Securities and Trading Technology(STT)
Mauritius Millennium IT ATS
Nigeria Nasdaq OMX
South Africa Nutron Trade Reporting System & Millennium IT ATS
Tanzania Securities and Trading Technology(STT)
Zambia Securities and Trading Technology(STT)
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Reduce costs for investors
Electronic system can aggregate a
greater number of bids
Solves the shortfall in the liquidity
Contributes to transparency
Provides more counterparties
Increased transparency can cut profits
Standardization is impossible
Single dealer platform model
poses a challenge
Requires a coordinated effort between
Many banks and investors
ADVANTAGES DISADVANTAGES
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Exchanges can leverage on their expertise from the equities market to develop
centralized electronic trading platforms
Their strong links with issuers and economies of experience in regulation can
minimize regulatory costs for both the sell and buy sides
As a revenue diversification avenue, Exchanges can capitalize of banks’ and buy side reluctance to develop all inclusive electronic platforms
Exchanges need to step in and address the fundamental problem inherent in fixed income markets that inhibits liquidity e.g. formation of Bond Market Associations as lobby groups
Exchanges could tap into passive “bought & held” inventory by promoting SBL to inject liquidity
Since exchanges are valued for their independent conflict-free model, they can reach their full potential when they innovate exchange-like ways of matching buyers and sellers of bonds
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IOSCO Principles for the Secondary Market
The establishment of trading systems including securities exchanges should be subject to regulatory authorization and oversight
There should be ongoing regulatory supervision of exchanges and trading systems
Systems should be designed to ensure that they are fair, effective and efficient and that they reduce systemic risk.
End –to-end surveillance to minimize systemic risk and market manipulation
Regulation should:
Promote transparency of trading.
Be designed to detect and deter manipulation and other unfair trading practices.
Aim to ensure the proper management of large exposures, default risk and market disruption.
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Key Aspects of MiFID
Authorization, Regulation & Passporting
Less Fragmentation
Pre & Post Trade Transparency
Better Execution & Fairer Competition
Efficient Market Control
Harmonized Legal Framework
Why should the African Regional Markets establish legislations such as the EU’s Markets
in Financial Instruments Directive (MiFID)?
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Revolutionary Impacts of MiFID
1. MiFID expressively recognizes 3 categories of execution venues:
a) The traditional exchange
b) Multilateral Trading Facillity (MTF)
c) Systematic Internalizer (SI)
2. MiFID abolished the “concentration rule” – the rules required investment firms to route orders to
the national exchange. Now firm have can use any platforms as long as they can demonstrate that
they have achieved best execution for their clients
3. This diminished the privileged position of traditional stock exchanges in Europe and the immediate
consequence has been the proliferation of exchange -independent execution venues across Europe
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• eSpeed Nasdaq OMX
• Bonds.com LSE Group
• Vega-Chi Liquidnet
• Bondcube Deutsche
Borse
• The rise of alternative execution venues
( ECNs, ATS) has brought competition to
stock exchanges
• These platform have, since MiFID, been
free-riding the exchanges' role of market and
company regulation
• Acquisition of technology driven companies is
seen as a strategic tool
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1. Cultivates diversity in liquidity:
Multi-dealer venues build an interconnected fixed income marketplace,
providing both buy-side and sell-side participants with opportunities to
access each other and form a valuable ecosystem for transactions.
2. Provides access to voluminous data:
To maximize liquidity and minimize execution costs, market participants
will leverage the plethora of data available in the market to make more
intelligent portfolio and trading decisions.
3. Benefits dealers:
With fresh pressures on balance sheets, bond dealers can no longer
hold large inventories without either regulatory or capital penalty.
Dealers will now be rewarded to help clients access liquidity on behalf of
a client and not necessarily trading against the client.
In order to drive success in electronic trading, stock exchanges need to create a
Multi-dealer platform. WHY?
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Envisioned Situation: Transparent Markets Centralized Exchange Trading Robust Information Dissemination Price Discovery Increased Liquidity Central Clearing Counterparty
Current Situation: Opaque Fragmented Market Over-The-Counter(OTC) Inefficiencies in price discovery Poor information dissemination Illiquidity Bilateral Counterparty Risk
•Primary
Dealers
•Clients •Brokers
The “sweet
spot” of
liquidity
Centralized Trading, Clearing & Settlement of Bonds
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Page 26
SECTOR 2010 2011 2012 2013 2014
Market Cap (P’ Bn) Gov’t
3.5
5.3
5.0
6.1
6.4
Corporate
3.3
3.0
3.2
3.2
3.2
TOTAL
6.8
8.3
8.2
9.3
9.6
Turnover ( P’ Mn) Gov’t
747.1
283.7
314.2
94.7
359.6
Corporate
10.7
41.4
18.0
-
-
TOTAL
757.7
325.1
332.2
94.7
359.6
Liquidity Ratio (%) 12% 4% 4% 1% 1%
Listed Bonds Gov’t
5
7
6
6
6
Corporate
31
28
29
29
29
TOTAL
36
35
35
35
35
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2010
• Bond Market Association conceived – a Bond Market development lobby group
• Bond Market Development Strategy established and BSE commenced implementation
2011
• Research published to create awareness about structural impediments in the Bond Market and propose the solutions
2012
• Bond Market conventions established and adopted
• Began construction of bond indices in consultation with market participants
2013
• Launched 3 Bond Indices in April: CorpI, GovI and BBI
• Botswana Bond Market Association launched in September
2014 • Bonds (including Government bonds) earmarked to trade in the ATS
With each of these achievements, consultation was undertaken between the BSE,
System Providers and Market Participants
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Aggression has to give
way to diplomacy
Efficient regulatory
framework
End-to-end surveillance to
manage systemic risk
Development of multi-dealer
systems
Markets and systems cannot be
forced onto market participants
Debt Markets
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CLOB model can enhance the e-trading of bonds as opposed to the current RFQ model. The markets
are however, far from ready for CLOB
Electronic trading offers more benefits even though there are some challenges that need to be
addressed for the trading platforms to be fully functional
Stock exchanges need to leverage on their expertise from the equities market in creating a central
platform to trade bonds
Development and ultimate success of e-trading of bonds should be underpinned by sound legal
framework, systems and processes that work efficiently
In developing markets, efficiencies can be better realised by harmonising or centralising the depository
with the trading system
Botswana’s migration to automation has progressed significantly, currently the bonds are earmarked to
trade in the ATS.
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