OTC trading platform of the year: TP Icap

A reductive view of fixed income trading would split the market into two camps: interdealer brokers and dealer-to-client providers. But the emergence of all-to-all platforms – where anyone can trade with anyone else anonymously – has started to blur the line.

TP Icap, the largest interdealer broker, looks set to hasten that trend with its $700 million acquisition of dealer-to-client venue Liquidnet, first announced in October 2020 and completed last March. TP Icap also has big ideas to expand its proprietary execution platform Fusion, which allows users to trade correlated assets within a single electronic liquidity pool.

These twin moves signal TP Icap’s aim to transform its business model from a voice-based interdealer brokerage to an electronic all-to-all venue. The plan is in its early stages but, if it reaches fruition, would prove a bold and disruptive development for fixed income, equities, derivatives and beyond.

Don McClumpha, TP Icap’s chief executive for global broking across Europe, the Middle East and Africa, is one of the key figures tasked with executing the plan. He says the Liquidnet deal gives TP Icap ready access to a pool of 1,100 asset managers and hedge funds.

“One of the principal reasons behind the group’s acquisition of Liquidnet was to significantly increase our diversification towards the buy side and the associated distribution opportunity,” he says, adding that the buyout provides “a quantum leap” in the firm’s efforts to automate its business.

The strategy is not without controversy. Interdealer brokers (IDBs) have been reticent to bring buy-side clients on to their platforms for fear of alienating their core dealer market. Those concerns have not abated, but a squeeze on IDB profits has left them torn between the needs of traditional banking clients and the desire to find new ones.

Constraints on the interdealer brokerage business model are, in part, a consequence of increased regulatory scrutiny of opaque voice-based markets since the financial crisis. The move to screen trading has also eroded margins, introducing demands on IDBs to cut costs.

At the same time, brokers’ client pools have shrunk as post-crisis rules forced dealers to hold more capital against trades and crimped balance sheets. The pinch continues to be felt today. According to Q3 2021 data from Coalition Greenwich, the 12 largest investment banks globally saw aggregate revenues decline by 16% year on year in fixed income, currencies and commodities markets.

McClumpha says the target market for interdealer brokers is dwindling and argues TP Icap must respond. “That core group of banks is diminishing,” he says. “Probably five years ago, there were 16 or so. Now there are less than 10. As a result, we have to diversify and add value to a wider audience.”

One of the principal reasons behind the group’s acquisition of Liquidnet was to significantly increase our diversification towards the buy side and the associated distribution opportunity

Don McClumpha, TP Icap

The firm has already taken steps in this direction. Icap was one of the first IDBs to allow non-bank market-makers access to interdealer swap markets. TP Icap already offers agency execution through its Coex brand, plugging the gap opened up by banks withdrawing services to certain clients such as hedge funds. Next in line are more traditional buy-side customers.

TP Icap contends its target audience is not top-tier asset managers but smaller firms either serviced electronically by banks or not really serviced at all; entities that require high-touch, value-added execution services and market information. McClumpha hopes the Liquidnet purchase will give TP Icap an entrée to those clients.

“That’s a space that we can fill, because our overheads and cost base are lower. But we can only really fill it if we’ve got the distribution tools to capture that audience,” he says.

All together now

Central to the strategy is the Fusion platform. With its focus on trading correlation, TP Icap thinks the electronic offering will be differentiated from the siloed approach that developed at many entities when voice trading was the method used by product-segregated broking teams.

“Part of our strategic plan is to bring together, on Fusion, correlated asset classes,” explains McClumpha. “There are multiple reasons for trading correlation but, essentially, you’re establishing positions based on the fact that you believe a relationship between two or more asset classes is going to change, and you want to exploit the potential change in that relationship. Corporate treasurers, asset managers, pension funds, they want to trade correlation.”

Secondly, he adds, often investors can’t hedge something they’ve just acquired some risk in, so the next best thing is correlated. One example would be hedging swaps against futures or swaps against underlying cash bonds.

Fusion is not designed for vanilla interest rate swaps, which are already traded electronically on swap execution facilities. Rather, it’s intended for more exotic products such as interest rate options and inflation swaps, which are still traded by voice. Fusion brings all these products together in an electronic matching engine. This will allow TP Icap to “surface and sell correlation in a much more active way than we ever have done before”, McClumpha says.

In the first instance, the correlated instruments will be listed alongside each other for the most liquid products traded through each desk. Client permissioning is configurable, so the majority of IDB clients will have access to all assets where they are able to trade them.

Evolution of the model could end up in all-to-all trading, as has already been demonstrated elsewhere in asset classes such as credit and equities. McClumpha says: “The pattern is beginning to repeat itself. What we’re trying to do strategically is make sure we are aligned and have built the underlying infrastructure to allow us to exploit that change.”

TP Icap is not the first IDB to try providing a market for both dealers and clients. In 2018, Tradition launched an all-to-all central limit order book for interest rate swaps. But the scale of TP Icap’s initiative is compelling because it offers up multiple instruments in one place to clients acquired through the Liquidnet purchase.

Indeed, McClumpha is keener these days to compare TP Icap to Bloomberg and Tradeweb – which have already blurred the lines between interdealer and dealer-to-client markets – rather than brokers BGC and Tradition.

“The plan is to develop a scalable technology footprint across the group that makes us more accessible and more relevant to more clients than we have served historically,” McClumpha says.

Match point

Starting in interest rate options, Fusion aims to move voice trading to electronic matching sessions, which has been achieved with the Icap brand, and is now under way with the Tullett Prebon brand. Interest rate options instruments include swaptions, swaption skews, mid-curve options, constant maturity swaps, spread options, Bermudans, caps and floors. Also supported are inflation products in the rates space, for outright swaps, spreads, flies, forwards and iotas.

Future plans, initially in sterling, will offer correlation trading by extending the inflation product offering across swaps and gilts, sitting alongside the options grids already available. Subsequent product launches will cover European government bonds, followed by currencies including euro.

Across a wider spectrum of assets, Fusion covers foreign exchange, equities, credit and Islamic finance products, and has plans to add commodities and digital assets later this year.

The gilts market is now almost completely electronic, while electronic execution in Icap options accounts for 45% of volumes, and for the Tullett Prebon brand around 20%. Electronic trading represents about a third of the inflation business.

In European government bonds the industry’s electronic base is split between streaming and matching platforms, and across different sovereign issues. Matchings provide up to 20% of IDB revenues depending on sovereign, and are estimated at just over 10% of total activity on average.

McClumpha says his longer term vision is building an entity where electronic orders are submitted with contingent trading in correlated asset classes in package-style trades. One benefit of executing package trades electronically is elimination of legging risk. This type of risk occurs when the first leg of the trade is completed, but then the price moves or liquidity evaporates before the second leg can be executed.

TP Icap ultimately plans to expand the European hub concepts to both the Americas and Asia regions. The firm is also looking to develop new data and analytics products.

The timeline TP Icap has set itself for completing its objectives is three years, a process helped by the pandemic as the trend towards remote working has catalysed use of electronic execution.

In terms of anticipated volumes on Fusion, TP Icap expects “an evolution, not revolution”, says McClumpha, with steady advancement, varied by desk and client appetite, with progressive year-on-year growth.

Clients like Fusion already. An interest rate options trader at a European bank uses it for swaption auctions and describes it as “easy to handle, straightforward and very intuitive”.

The trader isn’t bothered that buy-siders may soon be active on Fusion, as his bank “has a lot of restrictions on who we can deal with on the platform. When they expand it to other clients, we probably can’t use them anyway. We would be restricted by risk limits.”

However, a second trader, while also a fan of Fusion, raises the concern that has troubled banks in the past, namely the encroachment of IDB business models on to dealer territory.

The trader’s bank wouldn’t be restricted on trading with a wider array of counterparties and, “depending on exactly who uses it, it could prove to be a good avenue for liquidity for ourselves”, the trader says.

But they add: “Or it could feel like it’s taking our own client base away from us. Obviously, it depends on what form it would take. I can see why there would be demand out there to do it. Whether it would be something that could materialise and function is another question.”