Innovation in Focus: New Trading Models in US OTC Fixed Income Derivatives

Let Them Have Order Books
by David Easthope, November 28, 2012
Other
North America

Abstract

Electronic order books for the trading of US OTC fixed income derivatives are an innovative business design and have the potential to be disruptive. However, incumbents will not sit and watch market share slip away. We anticipate heavy competition when several new order books launch in 2013.

In Innovation in Focus: New Trading Models in US OTC Fixed Income Derivatives: Let Them Have Order Books, Celent describes innovative business models and technologies changing the way that fixed income OTC derivatives are being traded. We specifically focus on innovative order books for interest rate swaps (IRS) and credit default swaps (CDS).

In this Celent Securities & Investments Innovation in Focus Note, we augment our standard Capital Markets research reports by highlighting a key area within capital markets where technology innovation is leading to market disruption.

Although electronic order books (EOBs) by themselves are not innovative, when applied to highly manual, voice-operated dealer-to-client (D2C) swap markets, they have the power to alter them permanently. EOBs provide some strong and salient features to the swaps market, including enhanced transparency, wider access, and greater certainty of execution (at the point of trade). However, what they have in increased certainty (access, clearing, execution), they may lack (at least currently) in recognizable brand names. In the US D2C market, several public access order book designs are in progress to eventually become either swap execution facilities (SEFs) or designated contract markets (DCMs) for interest rate or credit default swaps, among other instruments, including Javelin, trueEX, and TeraExchange. Other near-order books are available from Tradeweb, MarketAxess and Bloomberg and will also likely become SEFs.

By being innovative, EOB sponsors could ultimately be disruptive. However, the scale of disruption that could take place requires a big leap of imagination because of stiff competition from incumbent players and because we cannot be sure of the ultimate liquidity of these instruments in a post Dodd-Frank environment.

“We believe electronic platforms, including order books, designed with features to capture existing workflow alongside new and innovative functionality will win in this scenario,” says David Easthope, Research Director with Celent’s Securities & Investments Group and author of the report.

This 19-page report contains four figures and three tables.

Celent is a research and advisory firm dedicated to helping financial institutions formulate comprehensive business and technology strategies. Celent publishes reports identifying trends and best practices in financial services technology and conducts consulting engagements for financial institutions looking to use technology to enhance existing business processes or launch new business strategies. With a team of internationally based analysts, Celent is uniquely positioned to offer strategic advice and market insights on a global basis. Celent is a member of the Oliver Wyman Group, which is a wholly-owned operating unit of Marsh & McLennan Companies [NYSE: MMC].

Media Contacts

North America
Michele Pace
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Tel: +1 212 345 1366

Europe (London)
Chris Williams
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Table of Contents

Executive Summary

1

Celent Securities & Investments: Innovation in Focus

2

Introduction

3

 

OTC Fixed Income Derivatives Market

3

 

The Innovation Cycle in Fixed Income

3

 

Innovation in Trading Models in Fixed Income

3

The End of the Beginning

5

 

Scenario—A Mini-Bang

5

 

New Trading Models for OTC Fixed Income Derivatives

5

 

Order Books Are Unique and a Recent Innovation

6

Innovation Scenarios for OTC Derivatives Execution

8

 

Innovation Scenario in Interest Rate Swaps

8

 

Innovation Scenario in Credit Default Swaps

8

The Rise of the Order Book

10

 

The Spectrum of Venue Types

10

 

The Near-Order Books

10

 

The Open-Access Order Books

12

Conclusion

17

Leveraging Celent’s Expertise

18

 

Support for Financial Institutions

18

 

Support for Vendors

18

Related Celent Research

19

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