Indexation and the new dynamics of EM bond trading

As local currency markets enter major global government bond indices, Emerging Markets (EM) are becoming part of investment and trading workflows historically prevalent in Developed Markets (DM). Index inclusion is bringing EM securities into a wider range of global bond portfolios, expanding the assets and liquidity considerations that asset managers need to navigate.

Evolving EM trading practices

Index inclusion is changing who participates in EM debt. The buyer base is expanding beyond dedicated EM strategies to include various index trackers, reserve managers, sovereign wealth funds, pension funds, insurers and other benchmark-oriented investors. Portfolio managers traditionally focused on DM sovereign debt are gaining exposure to local-currency debt once primarily viewed through an EM lens, bringing investment and trading practices established in developed markets into EM.

At the same time, the distinction between EM and DM itself is becoming increasingly blurred. Following South Korea’s inclusion in the FTSE World Government Bond Index (WGBI), markets traditionally viewed through an EM lens now represent around 15% of the index, making this convergence increasingly significant.

There remains a disparity between the actual size, maturity and dynamics of certain countries and how they are traditionally classified by the bond market. Large, mature economies such as China and South Korea, for example, have historically been viewed through an EM lens by many bond investors, even as their scale and economic importance have brought them into major global government bond indices. As these boundaries blur, global trading desks increasingly need to accommodate EM and DM practices within the same investment and execution workflows.

From global portfolios to regional trading desks

Global portfolio managers gaining exposure to EM securities do not necessarily execute those trades themselves. At large global asset managers, trades are often routed through established regional trading desks or centers of excellence, giving those teams responsibility for executing flows across local markets.

The DM mandates driving these flows often oversee significantly larger portfolios – even a relatively smaller allocation in those portfolios to an emerging market can translate into trade sizes materially larger than what might be the “norm” in a given market. Regional traders may need to reposition across multiple securities and local markets simultaneously, connecting global portfolio requirements with the specific liquidity, trading conventions, and dealer networks of individual EM countries.

Structural execution differences

Index inclusion has practical implications for how liquidity is accessed, and flows are managed. For example, Portfolio Trading is well established in developed markets, while EM trading has historically focused more heavily on trading individual bonds for better outcomes. As global portfolios gain exposure to EM securities, traders may need to manage larger, more complex flows across markets with very different liquidity profiles.

Some benchmark bonds attract deep, competitive quotes, while others have a much narrower pool of active dealers. While market-close execution is well established in DM, coordinating benchmark-related flows around local closing times can be more complex in EM, particularly for local-currency bonds where trading sessions and liquidity conditions vary across markets.

Managing execution at the market close

Global portfolio managers are accustomed to coordinating benchmark-related flows across different market closing times and conventions. Applying these practices across EM, however, can be more complex given the variation between local markets.

Instead of a common closing window, EM liquidity is fragmented across multiple local trading sessions and lack of consistent cut-off times, and coordinating these flows can create a significant amount of manual work.

To solve for this challenge, we built a product called Scheduled RFQ which allows a trader to prepare a RFQ in advance and specify exactly when it will be released to the market, by automatically calculating release times across local markets and time zones

A trader can therefore load a larger list ahead of time and schedule its automated release to align with a specific local market cut-off, rather than manually working through orders as each individual trading session closes.

Managing Transaction Cost Analysis (TCA) needs to evolve

Historically, global asset managers have conducted TCA at the individual security level, but in emerging markets that approach may need to evolve. For example, an inflow or outflow from a global EM index can trigger significant buying or selling across Asia, CEEMEA and LATAM.

In these cases, looking at execution quality security by security may not provide a complete picture. Investors may also need to assess the execution quality of the overall program, including how much market impact the flow creates in one trading session and how that impact carries into subsequent sessions as the market absorbs the flow.

The next phase of EM trading

Index inclusion is changing who invests in EM as well as how those markets are traded. As EM becomes more integrated into global bond portfolios, execution needs to accommodate larger and more complex flows across markets with different liquidity profiles, trading conventions and closing times.

We are working closely with our clients to develop the electronic execution solutions that give investors and traders more ways to access liquidity and manage complex flows across a global portfolio.

Providing access to over 30 local currency bond markets and with the most comprehensive coverage of the GBI-EM, EMBI and CEMBI indices across local and hard currency markets, we give investors the coverage and access they need to bring EM into a more integrated global trading workflow.