IRS Electronification: 20 Years in the Making

This article origially appeared in The Desk here.

With the 20th anniversary of Tradeweb’s interest rate swaps (IRS) marketplace around the corner, the firm’s head of US institutional Rates, Bhas Nalabothula, looks back at the key challenges and tailwinds that have defined the electronification of one of the most complex products in financial markets.

The DESK (TD): Twenty years is a big milestone, how is Tradeweb planning to celebrate the success of its IRS platform?

Bhas Nalabothula (BN): Funnily enough, we have lots of anniversaries coming up on Tradeweb. Next year, it is the 20^th anniversary of both our rates and credit derivatives marketplaces. It is hard to believe that our very first IRS transaction was completed way back in Q1 2005, paving the way for what the industry today considers as the home of swaps trading. And this coming October, our US Credit platform will be celebrating its first full decade.

As with every milestone, we will first reflect on the journey, what we did right and what we could further improve. Then we will make sure to acknowledge the efforts of everyone involved: from our employees to our liquidity providers and institutional clients, who have supported us throughout the years. Believe it or not, there are still people at Tradeweb and among our clients, who were there when we first attempted to electronify the derivatives space, and they deserve all the recognition. Especially, as the journey has been anything but straightforward. Everyone knows that derivatives and repurchase agreements have been the toughest markets to digitise, and for good reason. The common denominator with all of these product launches is the search for efficiency, liquidity and transparency.

TD: What were the challenges Tradeweb faced when it introduced IRS trading? How did you manage to overcome them?

BN: Where do I start? First of all, the biggest challenge was the nature of IRS themselves. They are incredibly complex, highly customisable financial instruments and to this day still, predominantly bilateral, not to mention extremely burdensome when it comes to admin. Bond trade confirmations are child’s play compared to swap trade confirmations. This is why several attempts to electronify their execution failed before us. We got lucky in a way, because we got the timing and the approach right. At the time, there was good transparency in benchmark tenors, and new tools facilitating better counterparty credit risk management were being developed. We also opted for a disclosed multi-dealer request-for-quote (RFQ) model, which was the obvious choice for us given our institutional background. The first inflection point was when dealers were able to price a swap relatively quickly. At Tradeweb, we already had a robust RFQ mechanism for bonds, and the ability to get responses to trade enquiries back for comparison. Subsequent drivers comprised voluntary adoption of clearing, before moving on to mandatory clearing and on-venue trading in the aftermath of the financial crisis and regulatory reform.

Regulation was definitely a big contributor to the success of the platform. We made the decision early on – and for every single product we trade on Tradeweb – to operate regulated marketplaces in all the jurisdictions where we are present. So, for instance, we did not have to scramble last minute to become a multilateral trading facility (MTF) in Europe and the UK ahead of MiFID II implementation. We have been an MTF since 2007, simply because we understand the importance of providing our customers with a safe, robust environment for risk transfer. Tradeweb was also one of the first organizations to launch a Swap Execution Facility (SEF) in the US in response to the Dodd Frank reforms. Moreover, we had all the necessary clearing pipes in place from voluntary adopters, who once they discovered the time- and cost-efficiencies of digitising their cleared workflows, they were eager to transpose them onto the uncleared world. Even today, the vast majority of IRS activity on our platform is not subject to an electronic execution mandate. Every day, clients are asking us to add new products to our IRS offering that are not mandated to trade on venue and are difficult to electronify, such as Emerging Markets currencies and bilateral swaps.

TD: Is there a secret sauce behind Tradeweb’s success in IRS?

BN: Our success did not happen overnight. Instead, it is the result of hard work, client support and market-firsts, such as our multi-asset packages, inflation swaps and cross-market trading solutions. We would not be here today, if we kept ourselves locked in a room trying to guesstimate what our clients need. And when I say clients, I mean both the buy- and the sell-side. Our approach has always been to listen to what their pain points, wish lists, concerns about the future are, and then go talk to our technology team and product experts about how to develop the right solutions that help address them. This is how our rules-based automated trading solution (AiEX), request-for-market (RFM) pricing mechanism, and the compression tool were born. They were the outcome of institutional client demand and dealer support. Without the latter, there is no way we would be able to deploy new tools or trading protocols. It has always been a partnership and we try to be very vocal about it, every opportunity we get.

Next, I am going to mention onions, reverse ones for that matter. At Tradeweb, we often use the ‘reverse onion’ analogy to describe how we construct and evolve new products. Essentially, we begin with catering to basic transaction types that are highly manual and inefficient, and then proceed with adding new functionality bit by bit, always in line with customer feedback. We never thought of ourselves as ‘market disruptors’, we do not tell our clients what to do. Our job is to make theirs easier, faster and cost-effective. We try to streamline, not just what happens around the point of execution, but also the post-trade side of things: connectivity to clearing houses, audit trails, reporting requirements or transaction cost analysis. You name it, we do it.

However, what really sets us apart from competition is our multi-asset offering, and our ability to connect markets and liquidity pools together. Trading desks today cannot afford to focus on one product or asset class only, so we strive to create seamless, flexible and efficient workflows powered by data. One great example of this is what we call AiSnap, a smart dealer selection tool using machine learning to identify the most competitive pricing, improve execution quality and reduce transaction costs.

TD: The sauce is obviously working given your 40% IRS revenue growth in January 2024. What is your future trajectory off such as strong start to the year?

BN: There are two sides to answering this question. First, we need to consider the current trading environment, which has been very favourable given the strong debate globally in rates, and the subsequent pick up of risk activity across the business. Second, we need to take a look at the IRS market itself. As I have said before, it is highly complex and digitising all of the different IRS workflows is no mean feat.

This is why in derivatives, we compete with our peers on innovation. And when it comes to innovation, we are second to none. When we introduced our compression tool in late 2013, clients were using it to offset swap line items at the clearing house. It has since evolved into a way to trade portfolios of swaps to put on new bespoke risk positions, and is a cornerstone of our IRS platform. Ultimately, it is important to maintain the value clients see in us, and this is why we have in place a balanced risk-based revenue model, in line with industry standards. We have stuck to this approach, even as we have evolved from outside challenger to a leader thanks to a constant stream of market-firsts. We offer a premium IRS product and its quality is reflected in the way it is priced.

TD: How do new entrants in the space impact your business model?

BN: Operating a multi-asset marketplace means we have multiple competitors, some with different business models and some that even work with us in one capacity or another. We thrive on competition, it spurs us to become better at what we do. The key is to focus on what we are good at and take nothing for granted. Buy-side traders choose Tradeweb not because they have to, but because we offer them a trusted, orderly, transparent and efficient IRS marketplace. Take hedge funds, for instance. Many of them do not even have order management system (OMS) connectivity with us, but they continue doing business on our platform regardless. Meanwhile, dealers provide liquidity on our platform because they appreciate our experience, expertise, level of service and customer network.

There is often talk of execution management system (EMS) providers aggregating platform networks with other pricing sources. Let us take a step back and look at RFQ. One of the merits of RFQ execution is distribution of information. This can help clients achieve risk transfer benefits, which are then maximised by the network effect of a platform. Context is essential for RFQ protocols and, therefore, its integrity should be safeguarded. If not, that would completely remove the RFQ context and, in turn, erode client execution quality over time. Executing a transaction outside the platform would decrease client hit rates, not to mention that dealers would have no idea who they are competing against. So, the idea of comingling multiple RFQs does not work, because that data no longer functions as a market.

TD: You mentioned data and automation earlier. What role will they play in the evolution of IRS trading?

BN: Our 20-year track record enables us to use the lessons learnt to make the lives of our clients even easier, and data has a great part to play in this. Digesting all the information stemming from trading activity on our platform and then feeding it back to our buy- and sell-side clients gives them deeper, more meaningful transparency into the depth of the market. The streaming pricing provided by the dealers offers buy-side traders a valuable way to get a sense of liquidity prior to execution.

One of the latest features that has resonated with clients across many products, including IRS, is the ability to set up custom streams and axes through the Tradeweb application programming interface (API), eliminating the need for multiple dealer connections and middleware support. They can also incorporate AiEX into their workflow and react quickly to changing market conditions or create new trading opportunities and signals. Data fuels automation and automation is powering the next evolutionary stage of swaps trading.