History and future of fixed income markets (in UK)..

Nice speech by Rohan Churm, Head of Foreign Exchange Division of Bank of England.\

The United Kingdom is home to one of the oldest financial centres in the world. Starting from within the
confines of London’s square mile – The Square Mile – but now spread widely around the country, the
United Kingdom has also become one of the world’s leading financial centres. In doing so it has been
central to centuries of innovation and evolution in the financial system.

The Bank of England’s first foray into fixed income markets came at its inception, in 1694, when it raised
£1.2m over 12 days, in order to lend to the government. This was an innovative way for the government of
the time to fund a war effort. But the original Royal Charter explained that the Bank was founded to
‘promote the public Good and Benefit of our People’. That aspect of the Bank’s mission has remained
timeless, even as the financial system has radically changed. That the Bank today can deliver its mission is
testament to how it has also innovated and evolved alongside financial markets and their participants.

If it feels like financial market participants must constantly adapt in order to thrive, then it would be helpful to
know we are not alone in this experience. It brings to mind the ‘Red Queen hypothesis’, which arose as the
academic field of evolutionary biology drew on the literature of Lewis Carroll. This idea was originally
proposed by US academic Leigh Van Valen. It posits that organisms that survive in a constantly changing
environment have themselves adapted and evolved. In Lewis Carroll’s book ‘Through the Looking Glass’,
the Red Queen warns Alice that it “takes all the running you can do, to keep in the same place. If you want
to get somewhere else, you must run at least twice as fast as that.” No doubt some of you can identify with
that as you consider how the City has changed over your careers, arguably innovating more rapidly than
ever before.

The Bank of England innovated in 1725 with the introduction of printed bank notes – moving away from the
handwritten ones.1 In the 19th century its lender-of-last-resort operations were novel and groundbreaking.
More recently, operational independence to set monetary policy and the new responsibilities for
macro-prudential regulation have significantly changed the shape of the Bank.

As we meet today at the London Stock Exchange (LSE) it is worth reflecting on how exchanges have
evolved. Not least because the LSE now has 14,500 listed debt securities and is hosting a fixed income
forum! When the Bank was founded in the 17th century stockbrokers would meet in the coffee houses of
Change Alley in order to exchange information and strike trades. Prices were first transmitted via the electric
telegraph in 1830. Today, in many markets algorithms ‘meet’ in a server centre to trade within fractions of a
second. Despite this, coffee shops are thriving.

He points that automation has been limited in debt markets:

at their core, FX and equities markets are based on homogenous instruments. As one moves towards
related but potentially bespoke products, such as FX and equity options, trading is far less automated.
The logic applies to fixed income markets, where bespoke aspects to bonds are often a central feature. A
typical large bank may have more than one thousand unique debt instruments associated with it, varying
across currency, coupons, maturity dates, optionality, and seniority, to name some dimensions. This
compares to ultimately only one equity claim.

This feature of fixed income markets is not a bug. It reflects product innovation that allows debt instruments
to suit the preferences and constraints of the investor, which ultimately lowers costs for the borrower. But it
does reduce liquidity. Most obviously, for any given amount of debt, more debt instruments means smaller
sized individual issues available to trade in the market. The bespoke characteristics also lead to market
segmentation as any individual investor may only be willing to buy a subset of bonds from a given issuer.
And from a practical perspective, investing in automated trading, with potentially bespoke programming, is
less likely to be worth it for small and unique issues with non-standard characteristics.

This means that fixed income markets remain somewhat slower.

Saying that, electronic trading is now a very standard part of fixed income markets. Automated trading has
also increased markedly, in particular in standardised or liquid instruments such as government bond futures
or on-the-run US treasuries.

Electronic trading is also increasing for corporate bonds. Our market intelligence suggests that around 50%
of all gross notional in the European corporate bond market is now being traded electronically. This has been
helped by the electronification of the corporate bond ecosystem, including the pre-trade, execution and the
post-trade phase of the trade lifecycle. And we have also seen growth of electronic trading platforms,
serving the dealer-to-dealer, dealer-to-client, and all-to-all segments.

Also discusses what next for Fixed income markets…


One Response to “History and future of fixed income markets (in UK)..”

  1. History and future of fixed earnings markets (in UK).. - Financentra Says:

    […] Good speech by Rohan Churm, Head of Foreign Exchange Division of Bank of England. The United Kingdom is dwelling to one particular of the oldest monetary centres in the planet. Beginning from inside the confines of London’s square mile – The Square Mile – but now spread broadly about the nation, the United Kingdom has also […] Source link […]

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