Risk Awards 2016
How does a buy-side firm enter the market without moving it?
It's an age-old conundrum, but one that has become particularly pertinent in fixed income, as capital-constrained banks have started to act more like brokers, working large orders in the market rather than holding risk on their balance sheets. With asset managers' intentions becoming increasingly widely advertised, the danger of information leakage and adverse price moves has never been greater.
"Prior to the crisis, a buy-side firm needing to trade a bond would typically contact three or four banks, and the bank offering the best price would win the deal. Now that most banks want to find buyers or sellers in the market rather than taking the other side, the noise is getting uncontrollable, and buy-side firms need to be super-sensitive about their information management to stop the price moving away from them," says Stu Taylor, chief executive of Algomi in London.
It was this challenging dynamic – familiar to many, but seemingly difficult to solve – that Algomi wanted to tackle when it extended its offering to the buy side last year. Founded in 2012, the company started out by delivering technology to banks to create an information network between salespeople and traders, helping them identify and prioritise trading opportunities.
Within two years, Algomi had signed up nine clients, as banks recognised the value of the technology in managing masses of information and bringing efficiency to the workforce, helping them manage their changing role in the fixed-income market. Today, Algomi is live with 14 banks and is aiming to double that figure by year-end.
Delivering technology that deals with structural changes in the market and persuading top-tier banks to pay for the wares of a start-up vendor was a major achievement in itself, but replicating that success with the buy side has shown Algomi's potential to become an indispensable layer of the market fabric.
The buy-side service, dubbed Algomi Honeycomb, gives users direct insight into the distribution capabilities of banks on the network, without those banks getting wind of a client's specific intention to buy or sell. Banks must grant individual firms access to a certain amount of data that will allow them to identify the dealer most likely to be able to execute on a particular trade, but that in turn puts them on a better footing to win the deal.
"With banks now often acting in a quasi-broking capacity and moving any risk off the balance sheet quickly to minimise capital charges, buy-side firms really want to have as few conversations as possible to avoid tipping their hand, while still finding the best bank to execute the trade. Honeycomb allows the buy side to listen in, by invitation, to what's happening on the sell side and thereby find the actionable liquidity," Taylor explains.
Achieving best execution for hard-to-trade bonds is a problem that has never been properly solved before, but by documenting the journey a firm has taken to analyse different banks and time its entry into the market, Honeycomb uses concrete statistics to prove best execution
Stu Taylor, Algomi
Analysing both real-time and historical data, Honeycomb delivers a profile on a particular bond – highlighting whether a bank has traded it or been close to trading it – which can give users some unprecedented insights. For off-the-run bonds that trade infrequently, for example, a buy-side firm wanting to sell can wait until a buyer registers an interest with the bank, triggering an alert in Honeycomb and allowing the firm to time its trade perfectly and minimise market impact.
At a time when asset managers are increasingly required to evidence best execution – for the benefit of their internal compliance teams as well as their own clients and regulators – Honeycomb also delivers a valuable audit trail to show how banks were surveyed and the best deal sought.
"Achieving best execution for hard-to-trade bonds is a problem that has never been properly solved before, but by documenting the journey a firm has taken to analyse different banks and time its entry into the market, Honeycomb uses concrete statistics to prove best execution," says Taylor.
Having formally launched the buy-side offering in February 2015, Algomi has since signed up 150 firms, of which 87 are now live. While its biggest footprint is in Europe, the vendor also has banks and clients connected in the US and Asia, and a physical presence on all three continents.
Buy-side firms using Honeycomb are keen to see the number of banks increase, because until all major market participants are on the network, there is still the chance of missing out on best execution. But there is also a general recognition of the value to be derived from being able to discreetly monitor the flows seen by the sell side.
"Honeycomb has the potential to become a tool we can't live without. It enhances what I do by helping me identify the dealer that is most likely to find the other side of my trade. Algomi has taken a completely different view on liquidity to everyone else and it clearly tackles the problems the market is facing," says John Orrock, senior trader and trade operations lead at BlueBay Asset Management in London.
For Algomi itself, there have been some growing pains as the company has matured and diversified. Towards the end of last year, it cut nearly 10% of its workforce and initiated an internal reorganisation. The company today employs 140 people, mainly in London, New York and Hong Kong.
"We went from zero employees to 150 in three years and inevitably you don't get all of them right, but what we have now is a very motivated and intelligent team that is very excited about the innovation coming out of the company. Playing in the information space, we believe there are many new opportunities we will be able to explore," says Taylor.