How fixed income index providers’ business models are evolving

The financial crisis has had a huge impact on the business of fixed income indexing. Illiquidity in many bond market sectors during the crisis has led to demands for greater transparency and for more exchange-based trading. Pricing models have had to evolve to ensure accuracy. Meanwhile, the demand for indexed fixed income exposure continues to rise strongly.

Journal of Indexes Europe editor Paul Amery asked representatives of two leading bond indexing firms—Sophia Dancygier of Markit and Brian Upbin of Barclays—about the challenges and opportunities facing their businesses.

Sophia Dancygier
Head of Fixed Income Indices,
Markit

JoI Europe: How much of the fixed income market will end up being traded on exchanges or other electronic platforms and what’s the impact of the regulatory push towards exchange-based pricing?
Dancygier: A lot of market participants are worried that the new regulatory regime, which requires full price and trade transparency for fixed income instruments, will harm liquidity. For the more liquid part of the market, electronic trading is already happening. Electronic Communications Networks (ECNs) have captured a large part of trading in government bonds, for example. One could also argue that public disclosure of bond pricing will boost liquidity as market participants seek to smooth price arbitrage by increasing the number of trades per bond.

As part of the European Commission’s review of its Markets in Financial Instruments Directive (MiFID), changes to permissible trading models for non-equity products are being discussed. It is likely that regulatory requirements will speed up the trend towards electronic trading, more broadly displayed transparency (both preand post-trade), and multilateral forms of trading. While this generally seems like a good thing, it is important that established trading models for less liquid instruments, such as request-for-quote mechanisms or voice supported execution mechanisms, are appropriately included in the new framework, to ensure that liquidity in these instruments is maintained.

Brian Upbin
Head of Index Research,
Barclays

Upbin: Even with a regulatory push towards exchange based pricing, it’s probably too early to predict how much of the fixed income market will end up being traded on exchanges or other electronic platforms. As an index provider, the responsibility of offering high-quality security prices doesn’t go away if more bonds move to exchange-based trading, especially if only a subset of the investable universe winds up on these platforms. Exchange prices will remain just one of a number of observable inputs that need to be evaluated to offer an appropriate index mark for both listed and non-listed securities.

JoI Europe: What are the pros and cons of single vs. multicontributor pricing models for bond index calculation?
Dancygier: One of the main advantages of the Markit iBoxx indices is their multi-contributor pricing model, which ensures that each bond is valued objectively.
Multi-contributor pricing, combined with an independent, objective and transparent price consolidation process brings (a) quality assurance and resilience, (b)
ability to penetrate deeper into less liquid markets, and (c) a better reflection of where the market, rather than one market participant, is trading (especially in less liquid markets). An index priced according to the contribution of one single firm offers the ability to execute at index prices, but of course this is inherently subjective and may be prone to biases based upon the price provider’s long/short position in select securities. This would result in a higher degree of tracking error, which is of course undesirable.

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