Is high frequency program trading inherently unfair? Does it improperly utilize technological advances? Does it allow front-running at point of execution? So many great questions, but to this point, the debate on this topic has completely focused on the equity markets.
Well, let’s shift the focus of this debate to the debt markets, commonly regarded as the bond or fixed income markets. What can we learn by comparison? Do the fixed income markets represent a fair comparison? As with any comparative analysis, do we have sufficient data to analyze and compare these markets? Non-financial people may be surprised, but the debt market across all sectors totally dwarfs the equity market in terms of size. Let’s frame the debate.
I view technological developments on the investment superhighway as having three lanes: analytics, risk management, and trade execution.
Whether in fixed income or equities, technology which can more efficiently and productively provide robust analytics is a great advantage and should be embraced. As a case in point, when I traded mortgage securities throughout the ’80s and ’90s, Bear Stearns invested in and utilized tremendous analytics. The Bear system was so advanced that it could literally analyze the mortgages in a mortgage-backed security to the level of the underlying zip code. No other dealer had those capabilities and it was a boon to Bear’s business. This technology was utilized to run a wide array of customer portfolio optimizations and helped Bear become the top mortgage shop on Wall Street. Bear’s downfall is a story for another time. The point being, technology which can more thoroughly review an investment product promotes competition and capitalism. There should be no speed limit on this technology lane of the investment superhighway.
The second technology lane on the investment superhighway entails risk management. When trading at First Boston, I and every other trader manually monitored our own risks, whether those risks were interest rate risk or credit risk. Management had no ability to view the overall risks across the entire fixed income division on a real-time basis, meaning at any specific moment in time. To say that First Boston was inefficient was a gross understatement. In going to Bear Stearns in 1990, I was blown away by the robust real-time risk management system. A trade from point of execution to entry into the system to updating my risk profile was literally a matter of a few seconds. What were the results? I could trade greater volume with greater confidence knowing exactly where my risk stood. There should be no speed limit on this technology lane of the investment superhighway.
The third technology lane on the investment superhighway entails trade execution. The fixed income market, much like the equity market, had traditionally been a person-to-person executed model. That process changed dramatically over the last decade with the development of a platform known as Tradeweb. This company was launched with equity capital provided by a consortium of Wall Street dealers. Tradeweb has revolutionized the business. Having started by executing trades within the U.S. Treasury market in 1998, Tradeweb now globally engages customers and dealers. Tradeweb executes trades across a wide array of market segments, including: a variety of interest rate products, the U.S. mortgage market, the corporate bond market, the credit derivatives market, and money markets.
Tradeweb not only engages in trade execution but is also fabulous at trade settlements and thus risk management.
Let’s zero in on Tradeweb’s trade execution because this is where the rubber meets the road — no pun intended — in comparative analysis with high frequency program trading activities in the equity markets. Tradeweb allows fixed income investors to engage Wall Street dealers across all of the aforementioned markets with trades executed within a matter of mere seconds. The playing field is completely level as dealers enter price levels, stand by them, and execute trades. If a Wall Street dealer is delinquent in responding to an investor inquiry, so be it.
Were Tradeweb to allow one dealer to see another dealer’s price level or allow dealers to instantaneously flash price levels without obligation of standing by their price, there would be hell to pay. Why? If dealers and investors knew that certain entities were provided preferential treatment by Tradeweb, then there is no doubt in my mind that Tradeweb would be out of business tomorrow. Make no mistake, the speed limit on the trade execution lane of the investment superhighway is extremely fast. How fast? Trades are executed within a matter of a few seconds. It works just fine for the hundreds of billions in daily volume compared to the relative odd lots traded in the equity market.
I strongly believe and embrace technology. I also have a soft spot in my heart for fundamental fairness and integrity. I think all global equity exchanges should implement the fixed income trade practices. I believe they are the best of both worlds.