Buy side using two-way prices in bid to hide trade intent

Number of trades done via ‘request-for-market’ protocol leaps 510% in past year

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European buy-side firms are increasingly asking dealers to quote two-way prices for interest rate swaps, in an attempt to hide their plans from the market.

Two-way pricing, also known as request-for-market (RFM), involves a firm asking for both the pay and receive price for a given instrument, instead of just one, as is usually the case in a request-for-quote (RFQ). In a multi-bank RFQ, some clients believe dealers that have been asked to quote – but not won the business – will use the information to trade ahead of the client.

Derek Milner, senior portfolio manager for derivatives and hedging at Aegon Asset Management in The Hague, says he is encouraging more dealers to offer RFM, as it allows his firm to conceal its trading intentions.

RFM offers protection as a client, as you don’t have to show your direction upfront so you don’t give away all information,” he says.

Milner says he tends to ask for RFM on larger trades executed over the phone, but use of the protocol is also growing on trading platforms.

Tradeweb launched RFM trading for interest rate swaps on its platform in 2013. There are now 13 dealers offering prices on RFM, versus 30 on RFQ. A spokesperson for Tradeweb says the platform is looking to extend RFM to the 18 dealers that currently support so-called list trading, in which multiple swaps are executed in one go.

RFM is a protocol we see expanding across the board, primarily in derivatives but growing in cash bonds also. Some of the newcomers in the electronic world – such as the hedge funds – tend to trade this way anyway, so as these firms come through, we’re getting more and more dealers offering RFM,” says Enrico Bruni, head of Europe and Asia business at Tradeweb in London.

The platform has seen the number of RFM-traded tickets increase 510% in the past year across currencies – representing a 117% increase in delta and 113% rise in notional in the same period.

Bloomberg currently offers RFM for electronic bond trading, but it’s understood the platform is looking to extend this to interest rate swaps in the near future for both spot and list trading.

RFM offers protection as a client, as you don’t have to show your direction upfront so you don’t give away all information
Derek Milner, Aegon Asset Management

Aegon Asset Management’s Milner says he trusts the firm’s dealers not to leak or use information gleaned from quote requests, but has seen occasions when an RFQ appeared to move the market against his firm. As an example, he recalls attempting to trade a receive-fixed, 10-year euro interest rate swap. He put three banks in competition via RFQ, but didn’t like the levels he was offered so chose not to execute. Shortly afterwards, the market moved, making it more expensive to trade. RFM would have prevented information leakage, which Milner argues would probably have resulted in a better execution level.

In foreign exchange markets, banks last year agreed a code of conduct that limits what traders can do with this kind of client information, which was partly an attempt to stamp out front-running. One of the bodies that helped co-ordinate the work, the Ficc Market Standards Board, is now turning its attention to fixed-income markets, where it argues bank traders need clarity on what they can and can’t do with client information.

In that context, some dealers also welcome the growing popularity of RFM, arguing it can untie the hands of traders that have quoted for a client, but failed to win the business. For a period of time following an RFQ, they might have been reluctant to trade the same way as the client – fearing it could look like they were abusing the information. That danger is reduced with RFM.

“The problem is when you have a one-way request. Say we missed on a deal – it puts our traders in a bind in terms of what are they restricted from doing. So they have got the information that a client is trading in this direction, but potentially they may be frozen out of being able to access liquidity themselves in that period,” says one US bank’s head of electronic trading.

He adds: “To defuse that problem, we’d prefer not to know which particular direction clients have traded in. A two-way market has the ability to remove ourselves from having any information that potentially could bind us from accessing liquidity.”

I typically use the RFQ model in the belief the banks will provide better pricing if they know my side
Mike O’Brien, Eaton Vance

But not everyone is a fan.

RFM is also available on Tradeweb’s swap execution facility in the US, however Mike O’Brien, director of global trading at Eaton Vance in Boston, believes he gets better pricing when using RFQ.

“I typically use the RFQ model in the belief the banks will provide better pricing if they know my side. The trade is in competition by regulation and on-the-run swaps are transparent, so I am not concerned about getting off-market prices,” says O’Brien.

This is backed up by Campbell Gilbert, head of interest rates trading at Mizuho International in London, who says he pushed for RFM to be introduced at his former employer, Deutsche Bank, because it gave traders more freedom when pricing.

When a trader receives an RFQ for a medium size, he says, they may feel pressure to show a price closer to mid, even if they’re not axed to do so. If the trader receives an RFM, they don’t know what direction the client wants to trade in, so will be more likely to show what they perceive to be the right price. The result could be less bunching around mid, Gilbert argues, but clients should still not lose out.

“If you say ‘Make me a market in a hundred million 10-year swaps’, and I quote 7/7.3 because I’m axed to pay, and someone else quotes 6.8/7.1 because they’re axed to receive, then the client will do whichever side make sense to them. Whoever trades that is happy, and the dealers in that case are happy,” says Gilbert.

The US bank’s electronic trading head, though, argues the difference between an RFQ and RFM price shouldn’t be any different in automated trading – dealers currently provide live bids and offers to venues, which then simply withhold one side when a client asks for a quote.

“When someone asks for a one-way price, all the system is doing is not sending the other side away to the client on the back of it. So it shouldn’t really make a difference for electronic automated pricing. On manual pricing, it probably does make some difference, but it depends on the situation,” he says.

Editing by Duncan Wood

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