Magazine Issues » April 2011

RISKY BUSINESS: transfer agencies under pressure

Shot_glassHigh-yield bonds are much in demand among investors. Nicholas Pratt examines how post-trade processes are coping with the rising volume

One of the most noticeable trends in the investment world in the last two years has been the rise in the trading of high-yield bonds, and according to the latest figures the appetite for riskier bonds shows little sign of reducing. Boston-based research firm EPFR Global reports that investment flows into the high-yield sector has exceeded $11bn (€12.5bn) so far this year and looks set to exceed last year’s total of $31.5bn.

And as long as high-yield bonds keep performing and producing returns – so far they are up by roughly 3% according to the Merrill Lynch High Yield Master II Index – they are likely to remain in demand. But while some may be cognisant of signs that these instruments are becoming even riskier amid fluctuating yields, others are more focused on the current capacity of the market’s infrastructure and how efficient current post-trade processes may be.

The fixed income market has certainly become more efficient but still lags behind equities when it comes to automation, electronic trading, transparency and the efficiency of post-trade processing. This is not to say that fund managers are hopelessly adrift in a mess of manual processes.

The asset manager

Allianz Global Investors has a full post-trade settlement process for multiple asset classes, including high-yield bonds, says Dave Hood, director of operations.
“We are a big believer in STP [straight-through processing] and partnered with Omgeo on the implementation of the Omgeo Connect infrastructure as an early adopter utilising the matching and settlement notification components of the system. It is automated from our order management system through to matching and settlement. It is good for us because we benefit from common platforms across asset classes.”

In terms of the clearing process for high-yield bonds at Allianz, once the portfolio manager has completed the trade in the trading system, it automatically flows into the downstream system (Omgeo Connect) for post-trade processing. Once the trades are matched they move into the settlement notification process and a Swift message is
sent to the custodian. Hood says: “Even though volumes for high-yield bonds have increased, our affirmation rates have too as more and more brokers have got on the system.”

Allianz has been pushing brokers to get on the same system in order to increase the industry’s efficiency. As Hood says, the tools for more efficient post-trade processing of high-yield bonds are all there. Several years ago there was a push towards more STP and shorter settlement cycles. The vendors started looking at asset classes outside standard equities and focused more on fixed income. The only obstacle to full STP for the likes of Allianz is the uptake of these services among the broker community.

“Most of the major brokers have adopted these systems and as a result our affirmation and conformation rates, particularly on trade day, have increased quite a lot, even with the increased volume we’ve seen over the last two years,” says Hood. “The only thing slowing us down is the fact that the smaller brokers are not utilising these systems and are still reliant on manual processes.”

Is it a case of the age-old problem that these small brokers are not the ones who would see the greatest benefit from automation so are therefore less attracted by the idea of adopting new operating models? “Yes, it is true that these brokers would see less benefit than we would,” he says.

So what can be done to make the benefits of STP for these instruments more attractive to these brokers?

“I think it is a matter of volume,” says Hood. “You do get to a point of diminishing returns when there is only a small volume involved and the effort involved to get brokers to a high level of STP may not be appropriate.”

And will the increase in volume create any capacity issues on the post-trade side and in the clearing and settlement of these trades?

“The infrastructure has always been there to support the clearing and settlement of high-yield bonds,” says Hood. “In the past there was a lot of capacity that was not being used so the increase in volume will not affect the ability to settle. The inefficiency really lies on the front-end and in not using existing tools for matching the trades and getting the notifications out in a timely manner.”


From a settlement perspective, hig-yield bonds are handled in the same way as other corporate bonds and the settlement facilities themselves are fully equipped with STP tools. However, asset servicing is far less standardised than settlement for high-yield bonds and other fixed income securities. This has led to calls from service providers for more harmonisation.

“The levels of standardisation vary across the globe and although Europe is ahead of other regions, this is still a big issue,” says Annette Brandt, director, product management at Euroclear. “That is why the ICSDs [international central securities depositories], together with issuers and their agents, are putting a lot of effort into harmonising the issuance process and the operational procedures to support  the core asset servicing of these securities.”

The International Securities Market Advisory Group (ISMAG) is an initiative sponsored by the ICSDs and involves trade associations, issuers, agents and investor representatives. The aim is to bring more awareness to the problems caused by an absence of operating standards and to establish best market practice that clearly details the data requirements for issuers in terms of formats and timelines, and the responsibilities of each party involved in the chain.

Brandt says: “The idea of creating an authoritative market practice book is to provide a series of templates for issuers around the globe to use for the issuance and communication of corporate actions and other post-issuance events that are unambiguous and standardised by the time they reach the ICSDs for processing. The goal is to increase the level of straight-through processing and improve the timeliness of such processing.”

High-yield bonds require specialised asset services. One example relates to the payment of interest to investors. For investment-grade bonds, these funds usually would be made available to credit bond holder accounts the night before payment date. However, with high-yield bonds, interest payments would only be credited upon receipt of funds from the issuer or its agent. Also, with bonds that have a lower credit rating, there is a higher probability of default – an area which is lacking standardisation.

Brandt says: “The default process is typically less standardised and more complex because defaults occur on an infrequent basis. But this does not mean more standardisation cannot be injected into the process.

“For example, when filing a default claim, we would propose filing a claim for the total position that we hold in our books for that particular security rather than having each and every client filing a separate claim. As well, when we collect instructions from each client, the use of standardised corporate action instructions should be promoted. It’s all about trying to find a way to communicate and process instructions that are as simple and straight-through as possible for issuers, their agents and our clients.”

There have been standardisation efforts initiated for other types of instruments in the past, with varying degrees of success. Very often the problem has been that those who need to inject more standardisation into the process, such as issuers or their agents, have the perception that they will benefit least from greater efficiency. Brandt, though, hopes that the various incentives that ISMAG’s initiative are promoting, such as giving accreditation to issuers whose operational procedures come up to standard, will encourage greater adoption.

“The more efficient an issuer appears to be, the more attractive its securities will be in terms of transparency, visibility and information flows to the potential investor,” she says.


Vega-Chi is the first multi-lateral trading facility (MTF) to offer investors an electronic, buy-side-only platform for high-yield bonds. It launched a platform for convertible bonds
in February 2010 and expects to launch its high-yield bonds service next month. According to the platform’s founder Constantinos Antoniades, there are 60 participants currently signed up and he expects this to rise to 80 or 90 by the year’s end.

As with the MTFs in the equities world, Vega-Chi promises to offer investors more transparent pricing, access to new liquidity and cheaper transaction costs. And as with the crossing networks, Vega-Chi also offers buy-side investors a chance to bypass the brokers. “The platform is buy-side only and fully anonymous,” says Antoniades. “Clients can trade directly with each other and with better prices than they would receive independently from a dealer.”

Whereas the conventional broker-based means of trading uses prices based on dealers’ market valuations, Antoniades says that clients can post their own prices and trade somewhere in the middle of that spread. “The prices are based on real orders rather than quotes and indications and I think this is closer to best execution, which is being pushed by the regulators.”

In many ways, it is a crossing network, similar to the likes of Liquidnet but with added transparency, he adds. “Vega-Chi is not technically a crossing network because it is a fully regulated and fully lit market and has all the properties of an exchange.” 

 The settlement of trades will be handled by BNP Paribas which will act as the central settlement agent for the platform. “We will offer full STP post-trade processing for any client that wishes to use it. But what we have found with the convertible bonds platform  -and what we expect to be the case with the high-yield bond platform - is that most investors are not set up to receive electronic instructions for post-trade processes,” he says.

Most only trade a small amount of high-yield bonds per day or per week and although they might have STP for their equities processing, there is not sufficient volume or activity to justify the expenditure in fixed income, says Antoniades. “We cannot force them to adopt STP so we offer a service that caters for both.”

As high-yield bond trading volumes increase and as buy-side forms become more acquainted with the electronic trading of these instruments, Antoniades hopes this will encourage greater use of automation and more efficiency on the post-trade processing side.

“Until now there has n­ot been much opportunity for clients because not many dealers cater for STP. But any time you move an asset class to electronic trading, improved efficiency and greater STP is a natural consequence. I hope this proves to be the case because it makes it easier for everyone.”