HSBC and other banks are expected to expand their partnerships with liquidity providers for fixed-income trading in an effort to cut costs and keep up with rapid technology changes, industry sources said.

Units are under pressure as bid/ask spreads have failed to widen despite the recent rise in market volatility. The economics of providing services to clients has diminished as fixed-income trading has become more automated in the past decade, liquidity has fragmented and smaller lots are being executed. That trend is not new and HSBC is not alone.

It has left many banks struggling to keep pace – not only with Wall Street giants like JP Morgan and Goldman Sachs, but also newer liquidity providers, led by Citadel Securities and Jane Street. The non-bank liquidity providers, or NBLPs, are now a huge part of the trading ecosystem, and typically have lower regulatory capital requirements. NBLPs accounted for a record 26% of total industry trading revenues last year, according to a report last week by Boston Consulting Group.

“The net result is a significant contraction of the economics for all liquidity providers, including the larger incumbent banks with bigger costs structures, who may also have less ability to be nimble and manoeuvre around market structure changes,” said Laurent Paulhac, CEO of bond trading firm Millennium Advisors.

That has intensified pressure on all firms to evolve at pace and innovate, making technology the crucial element. But that can be expensive and difficult.

“It’s a technology arms race. The technology budgets are insane; every year is a record investment and then the following year is another record, that’s just the reality now,” Paulhac told IFR. “It’s not just about dollars spent, but also an innovation culture, the right human capital and intellectual property. It not only requires material investment in technology and quant, but also takes time to iterate to get it right.”

That can make partnerships between banks and liquidity providers potentially even more attractive. They are already widespread and often involve the non-banks providing direct connectivity to deepen the liquidity pool and improve pricing, but it can also be a deeper alliance.

“A partnership becomes a way to accelerate the timeline to provide a quality product in terms of pricing and liquidity, and at a lower cost,” Paulhac said.

Millennium Advisors is an NBLP and started trading in 2010. An early mover for fixed-income electronic trading, it now has about 1,600 counterparties globally. Paulhac declined to comment on any client relationships.

Stretching partners

HSBC knocked back a report on Monday that it plans to outsource some of its fixed-income trading as part of the restructuring of its investment bank to cut costs and focus on areas of strength. Bloomberg reported HSBC had held preliminary talks on outsourcing with firms including Citadel Securities and Jane Street.

"That’s not the case at all," said Michael Roberts, CEO of corporate and institutional banking at HSBC. "We are highly focused on our fixed-income trading operations. That is a centrepiece of what we are going to be doing.

"Our fixed-income capabilities are really one of the strengths of the firm. We would never trade out those capabilities."

The bank already partners with electronic venues to help its trading liquidity, as almost all banks do. Industry sources said it is likely to expand those partnerships as it looks to shave costs, but not give up control by outsourcing.

Citadel Securities, the market-maker founded by Ken Griffin, has been developing plans for a service that would manage the guts of trading operations, including technology and order execution, and leave banks and brokerages to continue dealing with clients. Former senior Goldman Sachs executive Jim Esposito joined Citadel Securities in September as president, tasked with leading client and partner relationships.

Jane Street has discussed offering a similar service to banks, Bloomberg reported.

A white-label trading service could see NBLPs providing the technology front-end and much of the plumbing, but banks have to decide how much they are willing to give up to their partners. HSBC is likely to keep everything in-house for FX trading, for example, as it is one of the dominant firms, but there are other areas of rates or credit where it lacks scale.

Products are at different stages of evolution too. Treasuries have become increasingly automated for two decades, but in credit that has mostly happened in the last three to five years, squeezing profitability and putting pressure on management teams on how to adapt, industry sources said.

It is likely to leave executives investing in areas where they have an edge and can generate the best returns, and look for partners in other areas. That will enable banks to continue offering a full suite of products for their top clients across FX, rates, credit, equities and beyond, while improving liquidity and pricing in weaker pockets so clients don’t look elsewhere.

Source: IFR