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  Study of European bond market pinpoints post-trade OTC automation as an opportunity for tremendous increase in efficiency.
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BearingPoint: Bond market suffering from fragmentation and lack of settlement standards in OTC trading

BearingPoint in a recent study, concluded that there needs to be structural changes to the Euro market for bond products, in particular Treasuries.

BearingPoint believes the reason for these changes is continued market fragmentation, which results in a lack of transparency and high settlement costs. According to the study, the greatest boost to efficiency is anticipated to come from a standardisation and automation of post-trade securities settlements in what is known as OTC trading.

OTC transactions are directly settled by two parties without an exchange or trading platform(s) utilizing standardized processes. There is no uniform procedure for settling transactions in this trading segment. For the most part, trading is based on bilateral agreements between the trading partners.

The study also reveals that major banks can have up to 60 individual bilateral agreements. These types of agreement come with a high level of manual settlement activities in comparison with automated trading. The latter entails fully-electronic book-keeping and ensures accounts are settled at close of trade. In fact, the study's main objective was to examine and assess possible ways for OTC trading to move in the direction of the established clearing and settlement processes used in electronic trading.

Platforms under pressure to consolidate

Industry representatives polled for the BearingPoint study were voice brokers, Euro-wide electronic trading platform operators and representatives from over 40 banks. According to these respondents, they believe further improvements to platform processes will lead to a reduction in transaction costs, leading to a concentration in the number of opportunities for electronic trading in the fixed income market. From a market point of view, this is necessary if liquidity is to rise, and with it the appeal of government bonds as an asset class.

The study identifies the key drivers as: the increasing pressure on electronic settlement platforms to increase profitability levels, dwindling revenues from core business, the implementation of technology, and the settlement of transactions. In the medium term, voice brokers are expected to hold their own against electronic platforms in the inter-bank market. This is due to the wider spreads, and therefore better trader margins, which are common in OTC trading.

Change of ownership needed to change traditional business model

The change in ownership from bank to exchange operators of many platforms and brokers and information service providers, goes hand in hand with an increase in pressure to enhance the profitability of electronic settlement platforms. With ever more standardization, mostly in Treasuries, it is important for sales. However, this will only succeed if declining margins in core business can be offset by new products, more efficient back-office structures, and the compilation and sale of market-relevant data.


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