My data integrity is my bond

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Digitalisation of bond markets

My data integrity is my bond

Ouida Taaffe quizzes the co-founders of BondAuction about why they believe their new start-up can offer a different and more efficient service to smaller investors

The co-founders of BondAuction discuss, in a question and answer session with Ouida Taaffe, the digitalisation of the fixed-income markets and the role that their new start-up wants to play in using technology to create ‘a transparent, efficient and secure platform for issuers, investors and underwriters’. The firm has just been licensed by the Financial Conduct Authority.

Q. What does BondAuction do?

Spencer Maclean, co-founder and former Global Head of Bond Syndicate at Standard Chartered

A. We’re focused on the price discovery mechanism for a new bond issue coming to the market. So, instead of investors having to be reactive to a syndicate manager moving price guidance from treasuries plus 100 to 80 to 70, the question is reversed. We say, ‘these are the comparables in the market, both for the issuer and for recent new issues, so where does it make sense for you and your portfolios to be purchasing paper?’.

You can layer that information in and know that, if your bid is successful, you get rewarded on a best price basis and receive a full allotment. It does away with the ingrained problems of a regular book-build process where price inflation and order opaqueness are encouraged.

The traditional approach was to start marketing a transaction at a level that seemed wonderfully appealing – ie very wide of where fair value was – and then build an order book, receive inflated orders, and announce that the transaction was moving tighter because, surprise, surprise, we had two, three, or ten times the amount of orders that we needed for a given size. Eventually, you would land somewhere.

That became very frustrating for issuers, investors and banks alike. It was a bit like trying to read the tea leaves. You knew what would make a successful transaction in that you could definitely print a certain size, at a particular price. But could you print a bit more or a bit less at a different price? That was almost impossible to know with any real certainty.

BondAuction helps those smaller investors who may not necessarily be seen as platinum investors because they don’t come into every single transaction or they’re not trading lots in secondary. Unlike the banks, the issuers don’t particularly care about that. They want to know who is prepared to buy their risk at a certain level and to diversify the distribution.

Q. It’s sometimes argued that the bond market is too bespoke to digitalise. What’s your view on that?

A. The markets become complicated and difficult to read when you look at some of the subordinated structures. So, views on lower Tier 2 debt, such as the contingent convertible bonds at Credit Suisse, can be very different.

We still need banks to offer the underwriting and to do the due diligence and the documentation

If people want particular constraints, and certain structures around transactions, then you’re going much more to the bilateral market. We are looking at the larger, open, regular programmatic issuance. There, I think you can do an awful lot in terms of digitalisation.

Certain issuers have schedules of deals issuance. Corporates and financial institutions don’t do that. They come to the market on an opportunistic basis. There will be dialogue between an investor relations team and investors on a periodic basis to gauge demand. But, given that you’ve got well-understood ratings for senior unsecured, there’s no reason why a lot of this process can’t be automated and that’s exactly what we’re doing here.

Q. Does changing the distribution method cut into bank margins?

A. We still need the banks to offer the underwriting and to do the due diligence around both the end investor and the issuer itself, as well as the documentation. We’re not offering advisory to any party. We present the information, and we’ve deliberately pitched it so that it’s additive, not eating anybody’s lunch.

Q. What about bond origination being automated?

A. There are companies looking at that and some banks have built in-house solutions as well. We want to be part of the digitalisation of the ecosystem. If you’ve got term sheets and documentation created within a platform, the auction can be seamlessly created from that.

Q. What has the response been like?

A. We have a number of issuers who want to use the platform and we’re going through the process of registering banks and their end investors in order to bring a transaction to the market. We only received our authorisation from the FCA in early September after a year-long application.

Q. Everyone’s talking about AI. To what extent does this come into what you are doing?

Andy Cureton, BondAuction co-founder and IT specialist with more than 30 years’ experience

A. In our opinion, interfaces such as ChatGPT would be frowned upon by the FCA because there’s a potential for systemic bias given the information that the tools are ‘learning’ from. In the fixed-income market, the challenge is finding a single source of truth for data. If you look at reconciliation when a trade completes, there’s a system that just reconciles the names that each underwriter knows the investors by. That gives a clue to the kind of challenges with the data out there.

There’s been a generational shift, with fresher faces in the market more likely to submit orders electronically

In our platform, you don’t have that reconciliation process and we’ve been talking to Innovate UK about how, once we’ve got a volume of data, we can start to learn from that to provide, hopefully, value-add to all three parties – without moving into providing advice.

Q. Do ESG factors feed into what you’re doing? Do you try to collect that data?

Spencer Maclean

A. An auction is done on the best price basis and the reason we can’t filter out, or allow for people to filter out, investors is that there is no standard as to who is green. So, if you look at how primary markets are run for a green bond, you often see issuers step more into the allocation process. We talk about ‘allotments’ because they’re just logical best price, but an allocation process is a softer one where people are more involved in deciding who should receive the bonds.

Q. Where do you expect electronic bond trading to go over time?

A. There has been a bit of a generational shift; fresher faces to the market have proven more likely to submit orders electronically. I think you’re going to see more of it, certainly in the primary market and ultimately there will be a point when salespeople are not involved in the primary market order submission process in the way you see today. Will it go the same way as the stock market? Yes, it will do.

But the auction platform doesn’t do away with the need for a salesperson. The efficiency means you can have a more meaningful conversation as opposed to ‘change my order from five to ten’ and then deal with the grumbles afterwards when they don’t get what they want.

Q. What about the costs of implementing the new system? Is it about saving money, or about investing in something better?

Andy Cureton

A. It doesn’t cost a lot to put it in place. Our business model is that the issuer pays because, if you believe in auction theory, people being rewarded for the sharpest price will drive down the funding cost for the issuers – plus they get access to clear and accurate data in real time. The banks currently earn all the fees and, therefore, typically have to provide all of the systems for the investors, such as direct books and investor access, etc.

The net-net is that, as the platform is adopted, it will bring out a whole host of new investors to the primary market because it allows smaller players in. We are focused on a different revenue stream and, therefore, do not impact on fees the banks charge. Critically, there is still no fee for the end investor which ensures adoption across players of all size.

Q. What are the FCA’s technical resilience demands?

A. We have not encountered anything specific that we did not already have in place. Security, availability and operational resilience were key foundations on which our platform was built so there was nothing ‘additional’ that we were required to do to satisfy FCA requirements. Our platform is distributed and in the cloud and so is inherently resilient from that. We also have micro-services architecture that scale elastically on demand. In the old days, you would design an application monolith that was impossible to change and expensive to operate and maintain. The opposite is now the case.

We are working with lots of other solution providers across the primary issuance lifecycle and things are very much open arms as opposed to, historically, sharp elbows. The new breed is collaborative because, that way, you multiply everyone’s benefit. You’re only as fast as your slowest point.

Ouida Taaffe

Ouida Taaffe is the Editor of Financial World