Fixed income trade automation and its use during turbulent market conditions

The COVID-19 pandemic has accelerated the move towards automation, where one would normally expect volatility to decrease the use of automation technology.

In a regular market environment, the use of automation is evolutionary as clients adapt electronic trading to optimize their processes, test a range of new technologies and gradually adapt them until the new tools and components increasingly become part of their standard work practices.

Turbulent markets operate manually, however the current markets are of a vastly different nature as other inputs contributed to its turbulence, foremost home working. While unthinkable in the past, the new norm has proven that banks and asset managers can work remotely during a pandemic and not rely solely on working in an office.

Fixed Income: Automating the future

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This meant that screen real estate for many if not all market participants has decreased and has driven them to seek new solutions in the current market conditions. These institutions have had to adapt and electronify processes across the board to adjust to new market and work environments. The standard gradual evolutionary adoption of automation has been replaced by a revolutionary adoption. It’s clear that the benefits of automation are now being recognized by a greater number of market participants.

In general, automation works well if other conditions, such as dealer responsiveness and minimum slippage in the market remain constant, as the automated trading rules were configured during normal market conditions. After COVID-19, however, they have clearly changed. As a result, firms that have not been adjusting the parameters of their rules engine to these new conditions have seen trade ratios decrease.

From a trading perspective, real estate on screens can be limited when traders are working remotely. Thus, any standard task, including a small-ticket trade, likely becomes more time-consuming and prone to errors. However, by embracing fixed income trade automation in this environment, buy-side firms gain a competitive advantage. They had to quickly adapt and put a process in place for robots to handle smaller, time-consuming trades, traders can concentrate on other tasks that deliver greater value to their desk. After all, humans are more skilled than robots when it comes to navigating the current market uncertainty and more complex trades.

Adjusting automation systems in volatile market conditions

COVID-19 has had a broad impact on the industry, and traders and buy-side firms are still learning how to adapt. Furthermore, how should smart order routers (SORs) or rule-based engines be designed to adjust to turbulent market conditions and the majority of employees working from home?

First, the system must have controls in place both to detect volatility and to not trigger automation when volatility occurs. Additionally, traders should be able to easily switch the rules on/off as they see fit. If the trading desk wants to keep the rules active, they should be able to dynamically adjust parameters, e.g., tolerances against composite pricing. Ideally the system might adjust execution parameters according to market conditions. If the machine cannot execute the trade, the system must allow the trader into the automated process to take over the inflight RFQ and trade manually.

For firms that have not implemented automation technology but wish to, the first step is to decide where it will sit. It can either stay within the firm’s own system, where it can be controlled at the order-creation level and a liquidity comparison can be performed and sent to the best venue available, or the trading decisions can be outsourced to the trading venues and use their automation capabilities.

If the technology sits at the firm, the next decision is whether to build an SOR or buy one and integrate it into the firm’s system. Currently, there are only a handful of SOR providers. At the same time, it might be difficult and time-consuming to implement an SOR, so firms can choose to use a rule-based engine offered by a software provider that operates on the EMS that is connected to one or multiple trading venues. There are a few things that should be taken into consideration when choosing either an SOR or a rule-based engine, including: liquidity access, system controls, such as kill-switches, ease of use and customizable interface, to name a few.

Automation’s impact on the future of work, post-COVID-19

In the future, a greater number of companies might adopt more flexible work arrangements. Before this pandemic, it was unimaginable that major banks and investment managers could work mostly from home and still be able to operate as effectively as before. According to UK consensus data, approximately 5% of the workforce has worked mainly from home over the last few years. This could likely increase drastically over the next few years as COVID-19 could have a long-term impact on working arrangements.

In terms of automation, companies can turn up the percentage of trades executed automatically when working remotely and keep such executions down during office hours. A flexible trading system is important now and will continue to be in the future.

Beyond providing traders with time to dedicate to tasks that add more value, automation is also expected to help companies retain talent. Future traders will be drawn to firms that embrace automation technology, thus it needs to be considered an important component of talent acquisition in the new norm.

Regardless of what the future holds in terms of new, unpredictable market volatility and a longer period of working from home, automation has been instrumental in navigating today’s new environment. The pandemic has resulted in a renewed focus on how systems need to be built to tackle the challenges during times like these, and to provide a potential edge to early buy-side firms.