Buy-side traders relying only on requests for quotes for interest-rate swaps pricing could be missing out on best execution by not taking order books into account, a report by Greenwich Associates states.
Swap execution facilities’ order books are often able to get a better price for interest-rate swap trades than traditional RFQs, said Kevin McPartland, principal, market structure and technology at Greenwich Associates, Stamford, Conn., and author of the report, “Quantifying Interest-Rate Swap Order Book Liquidity.”
“Even if it’s getting just a few basis points in better pricing from using order books, even if it’s from one out of 20 trades, those basis points can add up,” Mr. McPartland said in an interview.
Asset owners as well as money managers, as fiduciaries, need to take note of best execution in swaps trading, Mr. McPartland said.
“As an asset owner, you want to be sure the people managing your money have access to all the potential sources of liquidity,” he said. “RFQs will remain the main source, but it’s time to pay attention to SEF order books, and it’s important for asset owners to continue to ask their managers how they’re looking for liquidity. … Looking at the prices in the order books should become part of the price-discovery process.”
Greenwich’s quantitative analysis of interest-rate swap trading data from July and August showed that in 92% of the trades, the midpoint price in order books from two swap execution facilities studied, ICAP PLC and TraditionSEF, was better than that achieved through an RFQ.
However, order books had drawbacks, especially in how much notional value they could take on. The Greenwich analysis showed that only 22% of the order books with the better price could handle the notional size of the trades. That, Mr. McPartland said, shows that one risk of using order books is that they might not handle an entire large block of swap trades.
“There are two issues related to size,” Mr. McPartland said. “One, the average-price issue, which is doing one big trade as many smaller trades or doing all at once. The second is, in talking to SEF platforms, they have created a workup process, in which the two counterparties in a trade agree to use an order book in a larger size than shown. The downside of that is there’s still the risk of not being able to complete the full block trade.”
Another issue relates to the cost of using both order books and RFQs for trades. “How much to pay for multiple execution fees should be taken into account,” he said. “You can save a few basis points on price but you need to see if that’s worth the added cost.”
Mr. McPartland said the study showed there’s a balancing act in using RFQs and order books in interest-rate swap trades, but the improved price is worth the effort.
“There’s potential for price improvement in order books, but you have to be aware of the roadblocks in using them. Order books should be part of best-execution workflow, but the buy side needs to be aware of the issues with doing that and do what’s best, for price and for cost.”
