Fixed Income Q&A with Eric Noll

Following his participation in the Fixed Income session at the 56th WFE General Assembly & Annual Meeting in Colombia, Eric Noll talks us through the big topics to come out of the panel.

Please give us an overview of Convergex and its operations.

Convergex is an agency-focused global brokerage and trading related services provider for multiple asset classes. Essentially, this means we provide different best execution services - electronic, high touch, algorithms and trading - exclusively for institutional clients. Our global footprint spans Asia, Europe and North America, and our clients include quant hedge funds, long only mutual funds, trust banks and pension funds, to name just a few.

It’s important to recognise the ’agency’ piece of our business as we don’t trade against our customers’ order flow; we don’t provide fundamental research; we don’t do investment banking; and we’re not selling capital markets deals.

You recently attended the 56th WFE General Assembly & Annual Meeting in Cartagena, Colombia, and took part in a panel discussion about the potential role of exchanges for fixed income markets. Is this part of a wider drive towards greater transparency by fixed income market participants?

The role of exchanges in fixed income markets is a little mixed. Exchanges may or may not have a role in the future of fixed income trading, but exchange functionality definitely has a role.

That may sound contradictory but what is ultimately going to matter is the creation and growth of electronic platforms for fixed income trading that allow multiple market participants to see the bid-offer spread and trade in a transparent way to maximise liquidity. While that might sound like the definition of an 'exchange’, and it is to some extent, there may be different variants on that model that do not neatly fit into an 'exchange’ bucket.

Several platforms are already doing some of what I just described, such as Nasdaq’s eSpeed, Tradeweb and BrokerTec, and others are also starting to create new venues to meet the fixed income trend. In some ways, exchanges are late to this game as they’ve been so focused on equities and options that they have not yet moved into fixed income securities.

If we take a closer look at the different models that exist between equities and fixed income markets, then this lag by the exchanges becomes understandable. For instance, an exchange usually works in a customer-to-dealer model or C to D. In other words, the customer will go to the exchange - the dealer - and make the trade. In fixed income, the model is dealer-to-dealer or D to D. A customer goes to the dealer to fill an order and the dealer fills that order from their own inventory or balance sheet. The dealers then trade with one another to flatten out their risk. Throughout this process, the customers did not have direct access to this market.

Traditionally, exchanges have not interfered with dealers trading with dealers. However, with new market regulations such as Basel III, MiFID II, Dodd-Frank and the Volcker rule, the dynamic of dealers being able to commit capital in those markets has diminished.

For price discovery purposes, investors prefer venues where they can access liquidity and competitive prices, rather than relying on their bilateral relationship with the dealer.

In short, as the world keeps changing, market participants are demanding more exchange-like functionality in fixed income markets. This is a difficult step for exchanges to take as they will essentially be competing with their dealer members in the fixed income space.

Can you comment on the factors behind the evolution of the US Treasury market, and the implications for liquidity and financing?

One key factor behind the evolution of the US Treasury market is that demand has never been higher. The recent US Presidential election may have added a layer of uncertainty, but the reality is that in terms of a global safe haven for an asset, US Treasuries are in great demand.

There is also this market dynamic of tremendous demand and tremendous supply. What you don’t have are market mechanisms that allow the demanders of liquidity (those who want to buy Treasuries) to easily access the supply. You have a C to D model with no public market or data feed. You can’t go online to look up the 10-year Treasury note bid-offer price since they don’t exist. Those factors can be a big impediment to the way the market is transacting and we’re going to see that evolve.

We could see that evolution playing out by regulators and exchanges starting to push for fully transparent bid-offer trading mechanisms, including market data tapes, that show the bid-offer, last sale and volumes, and mechanisms that allow customers to go into a liquid market place and buy and sell these securities without access to dealers. Is this going to happen tomorrow – probably not? Is this going to happen gradually over the next couple of years? Absolutely.

What are the other important trends in the fixed income space over the coming years?

The interest rate environment is eventually going to change, which will have a big impact on fixed income. While I do not have a crystal ball, I expect there may be a rise in US interest rates in December – which may be the first of many. I expect some international markets will follow suit in also raising interest rates. If that happens, we will begin to see much more volatility in the fixed income space then we’ve seen over the last few years.

Over recent years, interest rates have remained low in an effort to stimulate the economy, which has also created an environment with little volatility in fixed income markets. However, as rates change, you will begin to see much more volatility and activity in the marketplace. In fact, they’re already calling it the ‘Trump trade’ as after the election, interest rates on USD Treasuries spiked. The good news is that increased market volatility should result in more market activity across all asset classes.