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Featured Discussion
A Discussion with Marty Mannion & Matt Schrager of TD Securities Automated Trading
A Discussion with Marty Mannion & Matt Schrager of TD Securities Automated Trading
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Bond Dealers of America:
Bond Dealers of America:
Tell us about your professional backgrounds and how you both ended up running a fixed income automated trading business?
Marty Mannion:
Marty Mannion:
I was fortunate to start my career in the financial markets at NASDAQ in 2000 at a time when equities were transitioning to a more automated marketplace. This led to an opportunity to move to Citadel in 2004 to help buildout the equity and options market making businesses that formed the foundational pieces of the Citadel Securities franchise. In 2013 my former colleagues asked me to join them at Headlands to launch a fixed income trading business. Matt joined shortly thereafter from DRW, a leading proprietary trading firm, and the two of us have since partnered in running the group.
Matt Schrager:
Matt Schrager:
As Marty mentioned, I started my career at DRW as a software developer focused on fixed income pricing/analytics applications. Entering the industry, I assumed all markets resembled equities: automated, latency sensitive, efficient. I was therefore fascinated to discover that fixed income was on a different planet, with millions of symbols, sparse liquidity, messy datasets, and little automation. While equities traded in microseconds, fixed income traded over the phone. This, it seemed to me, was a new frontier. It presented new challenges, and enormous opportunity for increased efficiency through automation. So when I got the opportunity to join Marty at Headlands to build an automated fixed income business, it was a no-brainer. We’ve been working together to build the business ever since.
MM:
MM:
In July 2012, the SEC issued its “Report on the Municipal Securities Market”, which offered a range of proposals to improve the transparency and efficiency of the municipal market. As we’d seen in other asset classes, regulatory change often serves as the catalyst for the widespread adoption of electronic trading protocols. We believed the same transformation was about to take place in fixed income and we could apply the lessons learned elsewhere to munis. Our goal from day one was to build out a fully automated market maker that could provide immediate liquidity to retail-sized orders across hundreds of thousands of securities.
BDA:
BDA:
You came to TD in 2021 when the bank bought Headlands Tech Global Markets, LLC, where you were the Co-CEOs. Headlands had established a solid reputation as a leader in automated trading technologies. Can you talk about your experience at Headlands and how that is being utilized at TD Securities?
MM:
MM:
When we joined Headlands in 2013, the firm was already a leader in various futures markets around the world. Futures, like equities and options, trade in a highly automated fashion with liquidity concentrated on centralized exchanges. This makes pricing precision and speed, or what we call latency, critically important to running a successful liquidity provision business. The challenges in fixed income could not be more different. In markets like municipal bonds or IG credit, activity is fragmented across dozens of trading venues and the primary execution protocol is RFQ-based. A dealer must be proficient at managing a sizable inventory of securities and engaging with a diverse mix of clients and counterparties. Rather than shoehorn our business into Headlands’ existing futures-based infrastructure, we tailored the firm’s research- and tech-centric approach to account for the idiosyncrasies of the fixed income market.
While we had great success at Headlands, we and the partners recognized we could better scale the business as part of a larger financial institution. TD Securities ended up being the perfect partner. They have a world-class, global fixed income franchise and deep client relationships that would have been impossible to replicate as part of an independent, proprietary trading firm. TD Securities was attracted to our electronic trading capabilities, which they could extend across the dealer, and use to enhance the liquidity provided to institutional clients. This can take various forms, such as automated RFQ execution, streaming prices, and portfolio trading capabilities. In the year and a half since the transaction closed, we’ve significantly increased our presence in municipal bonds, ramped up our activity in IG credit, and started work on extending our footprint into other fixed income markets. We’re also partnering with internal desks at TDS to apply our technology-based approach in other novel ways, for example by providing workflow enhancement tools to institutional traders.
BDA:
BDA:
How does automated fixed income trading work at TD? What’s the technology behind producing quotations on an automated basis?
MS:
MS:
We can’t spill all the beans! But at a high level – as Marty mentioned, our roots are in low-latency markets, where automation is more advanced than in fixed income. A big part of our DNA has been adapting state-of-the-art techniques from those markets to the very different realities of fixed income. The result is an approach we believe to be quite unique within our space.
So what does that look like? Without belaboring the details, the throughline is that we try to push as far as possible with respect to automation and quantitative modeling. Quantitative modeling makes our pricing precise, whereas automation drives the marginal cost of incremental volume towards zero. Taken together, these factors allow us to provide clients with highly competitive liquidity on the vast majority of bonds they transact, no matter how many orders they need filled.
These themes permeate not just trading, but all aspects of our business. Our value to clients is our ability to provide competitive liquidity, and we can only do that if our cost structure is lean. This means applying automation not only to algorithmic pricing, but also to critical business functions like sales and operations. We challenge ourselves at every turn to minimize frictions and manual processes, knowing that every dollar we save is a dollar of value we can provide back to our clients in the form of more competitive pricing.
So – automation is not just the way we generate pricing, but the way we run the whole business, and we cultivate it as broadly as we can.
BDA:
BDA:
Headlands’ focus was predominantly investment grade municipals and corporates. Is that TD’s focus as well?
MS:
MS:
Yes, but not only those. We launched our business in municipals in 2014, but we never intended to “just” build a muni business. Rather, our goal was to build a world-class automated trading platform that could scale to many asset classes over time.
One way to think about this is: imagine asset classes as existing on a continuum of liquidity. On one side of that spectrum are highly liquid instruments like equities. On the other side, we find munis and even less liquid markets. Somewhere along that continuum, order latency starts to matter, and at that point we enter the domain of HFT firms like Marty’s former business at Citadel Securities. That’s not going to be our sweet spot; the technical trade-offs required to compete in those markets (FPGAs, microwave towers, etc.) don’t make sense in less latency-sensitive markets like fixed income. But that leaves a large swathe of asset classes that are not currently, and for market structure reasons will likely never be, truly latency sensitive. And we think our approach should scale to many of those asset classes over time.
Beyond trading, we also hope to promote our approach to building efficient technology-driven businesses more broadly within TD. It’s a trope that all finance companies are becoming tech companies, but it’s true: markets tend towards efficiency, and technology is a huge part of how they get there. Firms that embrace technology will thrive; those that don’t (or can’t) will struggle. TD is strongly committed to being in the former category, and we hope to partner with the great teams here to promote effective use of technology across the institution.
BDA:
BDA:
Automated trading in high-grade products and retail size trades has become an accepted staple of capital markets. But it has not really caught on in the institutional market, where price negotiation remains predominant. Why is that? Will we see the adoption of automated trading technology in the institutional market and in the markets for less liquid products like HY corporates or CMOs?
MM:
MM:
As we’ve seen in other asset classes, automated trading has quickly become the most efficient means of execution for retail-sized orders and is gaining traction in the institutional market; however, we expect price negotiation to remain the dominant execution method in the institutional market given the sheer number of tradable instruments in fixed income.
In an asset class like equities, you have just a few thousand securities, making it much easier to create centralized order books where dealers can stream continuous two-sided liquidity and natural buyers and sellers can find one another. This structure allows customers to piece out larger orders into smaller lot sizes for immediate execution. Even with these advantages, manual trading in institutional sizes is still prominent in equities, especially in less liquid securities.
Now compare this to fixed income where you have hundreds of thousands or even millions of tradable securities, many of which can go months or even years without a single transaction. In this type of market, negotiation is a more practical and efficient method for locating liquidity.
With that said, we expect continued advancement in the tools available to traders. This includes liquidity and data aggregation, more robust EMS and OMS capabilities, straight-through-processing of orders and executions, credit scoring, and real-time analytics. These tools do not replace traders, but rather allow them to do their jobs more efficiently.
We’re also excited about the progress we’re seeing in certain less-liquid markets, like HY credit and emerging market debt, where automated trading is making real inroads. For example, over 30% of the US HY market is now executed electronically. The use of fixed income ETFs and portfolio trading tools are helping to drive this adoption and we expect this trend to only accelerate in 2023 and beyond.
BDA:
BDA:
How was your experience during the March 2020 market volatility? How does an automated trading model like TD’s perform in a very volatile market?
MS:
MS:
The short answer is: extremely well. But let me provide some context that will hopefully both answer the question and also provide some insight into how we think about our business.
When running any business, it’s critical to consider: what are you being paid for? What value do you provide to the world that deserves to be compensated?
For us, the answer is simple: liquidity. We are paid to buy bonds from those who need to sell, sell to those who need to buy, and manage the risk between the two sides of that transaction. Some companies sell cars; some sell food; we sell liquidity.
Like any product, the value of liquidity is determined by supply and demand. In calm markets, liquidity providers feel safe and clients are patient: liquidity is in high supply and low demand. But in times of volatility, those dynamics reverse. Volumes rise and skew to one side; clients sell rapidly to meet redemptions; liquidity providers become nervous about their own portfolios. Liquidity shifts to a regime of high demand and low supply.
Such an environment presents unique challenges and opportunities to liquidity providers. On one hand, it ruthlessly exposes flaws: if a firm has deficiencies in pricing, risk management, technology, funding, etc., significant losses are possible. But on the other hand, it also creates an opportunity to provide liquidity to the market when it is needed most and available least, which is when its value is highest.
This is exactly what happened in March 2020. Clients desperately needed liquidity, and thankfully we were able to provide it very effectively. Our automated approach allowed us to manage flows dynamically, so we were always comfortable with our risk, even as volumes skyrocketed.
And the results were pretty staggering. To cite just one example of how differentiated our approach was during that time: MSRB subsequently released a study that showed that during that period, our market share of customer sales was nearly equal to that of the next eight dealers combined.
So – we are very proud of our performance during March 2020 and think it’s a great example of how automation and quantitative modeling can be value-additive to the market.
BDA:
BDA:
When FINRA and the MSRB were looking at the issue of pennying several years ago, Headlands was a very visible participant in the conversation. What are your thoughts on the issue and do you think we will ever see regulatory action on pennying?
MM:
MM:
We continue to believe the widespread use of pennying is harmful for the competitiveness of the markets and results in worst execution outcomes for retail investors, especially in municipal securities. As we noted in our comment letter several years ago, pennying deters dealers from participating in the bid-wanted process, since they know the submitting dealer may step in front of their winning bid. Even when a dealer does participate, it may submit an inferior price since the likelihood of adverse selection when executing the auction is much greater. This practice harms the price discovery process and reduces the likelihood that a customer will receive the best possible price on his or her order.
Requiring a submitting dealer to place its own price in the competitive auction would put all liquidity providers on equal footing and encourage more frequent and aggressive pricing by auction participants, thereby improving pricing quality for customers.
We are still optimistic that we will see regulatory action on this front, possibly tied to updated best execution rules. Markets tend to efficiency over time, and this practice does not exist in other asset classes that are further along in their electronic trading evolution.
BDA:
BDA:
What’s your outlook for the fixed income markets and business generally? How has the 2022 rate spike affected your business? What’s your view on the state of liquidity?
MS:
MS:
We’ve never been more optimistic. The return of interest rates is a long-awaited tailwind to businesses like ours. Touching on a prior answer, the value of the service we provide (liquidity) is proportional to the market’s demand for it. Rising rates and volatility increase that demand by giving people reasons to trade, whether it’s asset reallocation or cash management or tax-loss harvesting or anything else. This produces many opportunities to provide value to clients, which is ultimately what we’re in business to do.
Regarding liquidity, our view is: it’s stronger than ever, and yet still not strong enough. To expand on this, it’s helpful to consider fixed income markets in a broader historical context.
As mentioned, our background is in efficient markets like equities, where regulation and automation have driven trading costs for retail investors to near-zero. In our view, fixed income is on the same journey, but much closer to the beginning. Fixed income will never look exactly like equities, but the same themes – regulatory change, automation, spread compression – are in place, and will directionally lead to similar outcomes.
These changes are happening as we speak. Electronic trading has exploded in popularity. Important regulatory progress has been made, such as the establishment of MSRB Rule G-18 on best execution. Bid-ask spreads have narrowed significantly, especially in retail sizes. These changes have supported the growth of buy-side business models like SMAs, which rely on consistent liquidity in retail size orders. In this sense, liquidity is stronger than ever.
But we’re in the early innings. Regulatory enforcement often takes time to catch up to rulemaking. For example, we still regularly see examples of filtering, where retail customers are prevented from interacting with our liquidity, despite us being the largest retail liquidity provider in the market – in our opinion, a clear violation of best execution.
Having said that, we are incredibly optimistic about the future of the space. Markets tend towards efficiency, and fixed income will be no different. We are excited to be part of that story.
BDA:
BDA:
What regulatory and compliance issues nag you the most?
MM:
MM:
We applaud FINRA, the MSRB and the SEC for the progress they’ve made over the last decade in transforming the fixed income markets. As we mentioned earlier, expected regulatory change was a key driver in our decision to launch a fixed income trading business back in 2013. Best execution, mark-up disclosure, order handling guidance and efficiencies in trade reporting have all contributed to improvements in execution quality and fostered a more competitive marketplace where a diverse range of market participants can now compete for retail orders.
While we believe the right rules are now on the books and the market is much more efficient and transparent, there is still work to be done. As we’ve seen in other markets, it can take time for all participants to adjust their internal policies and procedures to catch up to new rulemaking. As Matt mentioned, we still encounter issues of filtering, which prevents retail customers from interacting with our price levels despite the fact we are the largest liquidity provider in the municipal retail market. We also encounter aggressive mark-up and mark-down amounts but suspect these will continue to tighten as overall spreads compress. We’re optimistic that the ongoing enforcement of these new rules will eventually change this behavior.
The SEC’s recent best execution proposal sends a clear signal to market participants that the experience of retail investors will continue to be an area of focus for the regulators. In particular, the SEC proposes that “conflicted transactions” with retail customers, meaning when a broker-dealer executes orders as principal or riskless principal or receives orders from an affiliate, be subject to more robust policies and procedures.
As an industry, we’ve made significant progress in improving transparency and execution quality over the last few years and we expect this to continue in 2023.