Europe’s Battle of the Bonds

Belgian and Dutch skirmishes herald trading shake-ups.

After months of jockeying and posturing, trading firms appear to finally be making Europe’s government bond market competitive. And although it’s too early to say which electronic trading platforms will prevail, dealers and investors are already reaping the benefits of lower trading costs.

In April the Dutch government ended the monopoly enjoyed by MTS Amsterdam, the local arm of Italy’s MTS Group, by allowing primary dealers to fulfill their market-making obligations on three other platforms: BrokerTec, a unit of London-based interdealer broker ICAP; eSpeed, operated by New York–based BGC Partners; and Eurex Bonds, a joint venture of Frankfurt-based Deutsche Börse, SWX Swiss Exchange and ten major banks. Also that month, Belgium authorized BrokerTec and eSpeed to compete with MTS Belgium.

Since the launch of the euro in 1999, most European governments have required primary dealers to make markets on national electronic platforms operated by MTS, believing that a single venue would concentrate liquidity and reduce trading — and, ultimately, borrowing — costs. But the rise of rival platforms and the introduction last year of Europe’s Markets in Financial Instruments Directive, which seeks to promote exchange competition, are forcing change.

MTS, which handles more than €85 billion ($132 billion) of bond trades a day across Europe, contends it is holding its ground. “We believe we are well positioned in Belgium and the Netherlands to withstand the entrance of new competitors,” says Angelo Proni, head of new and domestic markets at MTS in London. “The attractiveness of our markets, their liquidity and efficiency are well proven.” It also helps that many banks own a stake in MTS’s national subsidiaries.

But with alternatives available, some dealers are voting with their feet. In April, Credit Suisse stopped making markets on MTS Amsterdam and MTS Belgium to protest a decision by EuroMTS, the group’s pan-European platform for jumbo bond issues, to give direct access to hedge funds. Many dealers regard that move as a competitive threat because it lets hedge funds trade in the interdealer market without having to quote two-way prices.

The new competition forced MTS Amsterdam to cut its fees by about 25 percent, on average, in April. The firm declined to disclose trading costs under its revised tiered fee structure, but in the first quarter nonprimary dealers paid €3.80 to €6.70 per €1 million traded, including membership fees, depending on their volumes. By comparison, BrokerTec charges a flat rate of €5 per million and seeks to attract small to medium-size deals.

In addition to enjoying lower fees, dealers welcome the competition because of concerns about MTS’s intentions. The Italian company, which is majority-owned by the London Stock Exchange, announced in 2006 that it wanted to buy out local partners in its national bond platforms. Although MTS has since set aside that ambition, dealers worry that the group could revive that goal and take steps, such as allowing in hedge funds, that are contrary to their interests. The new platforms provide dealers with “some protection against future events,” says Aaron Rowe, co-head of European flow trading at Morgan Stanley in London.

John Edwards, director of European fixed income at ICAP Electronic Broking, contends that BrokerTec has an edge over MTS because it enables dealers to trade bonds, repurchase agreements and other fixed-income products on a single platform. Barclays Capital, Credit Suisse and Société Générale are fulfilling all or part of their Belgian and Dutch quoting obligations on BrokerTec.

Some observers worry that the competition could backfire by fragmenting liquidity. “Where in the markets will you find the best price if volumes are shared across different places?” says Peter Dunne, a lecturer in finance at Queen’s University Belfast.

Notwithstanding those concerns, more governments are expected to open up their markets. On May 30, Agence France Trésor authorized BrokerTec as an official platform. Italy and Portugal are expected to allow competing platforms soon. And all eyes are on Germany, home of the Bund market — Europe’s largest government bond market. Given that Eurex Bonds is based in Germany, most dealers believe it is only a matter of time before Berlin joins the bond platform party.

Related