By Egidio Onesti.
The bond market, traditionally known for its stability, is undergoing a significant transformation. This change is driven by the rapid adoption of technology and the evolving regulatory landscape. The bond market landscape is evolving, with Algorithmic trading gaining considerable momentum, creating opportunities but also presenting new challenges. This article explores Euronext’s innovative response to these emerging market dynamics.
Over the past ten years, the European bond market has undergone significant transformations driven by technological advancements and the increasing use of algorithmic trading. Recent events have confirmed the growing impact of electronic and algorithmic trading on market dynamics, influencing liquidity, efficiency, and the overall structure of the bond market.
Among the most recent developments, it is worth highlighting the publication of the European Stability Mechanism’s (ESM) report “Electronic trading – a boost to ESM bond market resilience” in November 2024. The report strongly endorses electronic trading in bond markets, stating that the evolution of electronic markets supports market efficiency by increasing secondary market liquidity and improving the efficiency of primary markets.
"These advantages enable the ESM to issue bonds more effectively, in support of its mission to uphold financial stability in the euro area."
Indeed, ESM data on €1.2 trillion in transactions involving its securities, show that the share of electronic trading has risen significantly. Value has risen from 40% to 60% over the past decade, while number of trades has increased from 55% to 80%.
Figure 1 - A diagram illustrating ESM and SFSF bond operations - Source [1]
This transformation is clearly illustrated by the chart in Figure 1, which shows MES and EFSF bond transactions over nearly a decade. Blue represents electronic trading, yellow represents voice trading, and the size of the circle indicates the transaction size.
Even more noteworthy is that electronic trading is no longer limited to smaller transactions; high-value trades exceeding €50 million are now routinely executed electronically.
Even more surprising, however, was the result of the analysis of electronic trading volumes during periods of extreme bond market volatility, such as the critical phases caused by the COVID-19 pandemic, the Federal Reserve's interest rate hikes in 2002, or the turmoil triggered by the collapse of Silicon Valley Bank in 2023.
In instances of great uncertainty and instability, electronic trading volumes dropped by up to 10% on days when bond market volatility reached the 99th percentile. However, volumes returned to normal within a few days, highlighting the stabilising effect of electronic trading during market stress.
The transformation of the corporate bond market has been more significant still. After decades of inertia, the share of trading volumes on electronic platforms grew substantially after the pandemic. In fact, following the pandemic, many companies increased bond issuance to cope with economic uncertainty, leading to record-high issuance volumes.
The number of credit market participants grew, the number of transactions increased, and more and more trades were handled electronically, though initially, they were smaller transactions. A contributing factor was the increase in the speed of technology, paired with a simultaneous fall in technology costs. Additionally, the introduction of young traders into the market, the increasing collection of data and analytics, and the development of pricing strategies fuelling further trading strategies, ETF arbitrage, and portfolio trading all played a role in this shift in market dynamics.
Bloomberg’s acquisition of the most widely followed bond indices, and their dissemination via its terminals further accelerated this trend. This evolution created undeniable benefits for investors, cementing the shift as irreversible.
Figure 2 – Percentage of electronic bond trading (%) - Source: Coalition Greenwich
The chart shown in Figure 2 illustrates the US bond market’s transition toward electronic trading, highlighting its varied impact across different segments based on the characteristics of the securities. Both the investment-grade and high-yield segments have seen an increase in electronic trading penetration. Notably, even less liquid and more fragmented markets, such as the high-yield segment, have experienced an expansion in electronic trading. This suggests that technologies and algorithms are becoming increasingly sophisticated, enabling greater adoption even for more complex instruments and less liquid, fragmented markets.
The spread of algorithmic trading, alongside major disruptive events, such as the "flash crash" of 6 May 6 2010 − when the US stock market suffered a sudden collapse – has created unprecedented challenges for regulators. In Europe, the implementation of MiFID II in 2018 introduced stringent rules, requiring greater transparency, rigorous algorithm testing, and detailed transaction records. Companies today must now ensure that their algorithmic trading systems comply with regulations, guarantee operational continuity, and operate securely by conducting thorough risk and transparency checks in their operations. Once again, technology has become a key tool in regulatory compliance. Both regulators and companies have started developing advanced monitoring and analysis systems that help detect and prevent abusive, suspicious, or irregular market behaviours in real time, thereby ensuring market integrity.
In the "MiFID II/MiFIR review report on Algorithmic Trading," published in September 2021, ESMA acknowledged the overall positive feedback from stakeholders of the MiFID II framework for algorithmic trading, finding no fundamental issues. It concluded that the existing regulatory framework has effectively met its objectives. However, ESMA identified specific areas for improvement, particularly regarding Regulatory Technical Standard 6 (RTS 6), which outlines the organisational requirements for investment firms engaged in algorithmic trading.
ESMA proposed enhancements to the organisational requirements established in RTS 6, including:
- Improving testing and deployment protocols for trading algorithms;
- Implementing robust risk controls, such as a "kill switch" functionality to promptly stop malfunctioning algorithms;
- Mandating comprehensive self-assessments to ensure that firms' systems and controls are effective and up-to-date.
The proposed recommendations aim to simplify and enhance the existing framework, ensuring that it remains strong and adaptable to evolving market dynamics. These insights have been presented to the European Commission for consideration in future legislative initiatives, reaffirming ESMA’s commitment to maintaining a fair, transparent, and secure trading environment within the EU.
Euronext's approach to algorithmic trading
The rise of algorithmic trading has intensified competition among market participants. To remain competitive, financial institutions have needed to significantly increase investments in advanced technological infrastructures and low-latency systems. These investments not only enable faster trade execution, but also allow real-time responses to market fluctuations, thereby improving operational efficiency.
In this evolving landscape, Euronext’s ultra-low latency trading solution, Traderpath, exemplifies how technology can transform market interactions by providing a modular suite of multi-market and multi-asset services for professional trading.
Within this Euronext solution, algorithmic trading functionalities are delivered through the Algopath module, which enables the implementation of sophisticated trading, quoting, and pricing strategies. Algopath is an open, high-performance, low-latency, and scalable algorithmic environment. It offers access to pre-integrated standard algorithmic strategies, along with an intuitive user interface for quickly and easily building and testing proprietary algorithmic models.
Algopath stands out for its technological and commercial neutrality, as it is designed to integrate seamlessly with any third-party trading platform. To meet market demands that require an extreme focus on latency, Algopath has leveraged all available technologies in a synergistic manner to achieve ultra-low latencies on conventional hardware.
Figure 3: Technologies used by Traderpath to reduce latency in ultra-low latency systems – Source: Euronext
However, to fully exploit the opportunities arising from achieving extremely low latencies, the ideal topological placement of ultra-low latency solutions is as close as possible to the core of trading and market data, meaning colocation with the market itself. This ensures the fastest possible access by eliminating all potential latencies introduced by the network.
When considering Euronext services, colocation within the Bergamo infrastructure offers additional benefits to its users, including:
- Reduction of propagation delay: fewer components for packets to pass through;
- Reduction of transmission delay: physical proximity to matching engines and market data infrastructure;
- Reduction of processing delay: significantly fewer components involved in packet processing.
These benefits translate into clear functional advantages, such as improved algorithmic trading performance, increased likelihood of accessing available liquidity, the ability to react more quickly to market changes, and the elimination of network capacity constraints.
Focusing on bond markets, it is important to note that in May 2024, MTS − the largest European market for supranational and government bonds − successfully migrated its Data Centre to the Aruba Global Cloud Data Centre in Bergamo. This synergy between Traderpath, Euronext Colocation, and MTS positions the European exchange at the highest level of competitiveness in providing solutions for algorithmic trading in European bond markets.
Having trading strategies co-located with the cash market is not always enough to complete bond market operations effectively. The need for synchronised, high-speed operation across multiple markets requires algorithms to be co-located in multiple trading venues. For example, it is common to trade simultaneously on a cash market like Euronext MTS in Bergamo and the Eurex futures market in Frankfurt to hedge risks through derivatives trading.
To meet this requirement, Traderpath's technology has developed a high-performance cache distributed across a network of installations, allowing algorithms to always use co-located data. As a result, no data is transferred between different geographic trading venues − only signals − significantly increasing the efficiency of the entire distributed system.
Euronext's approach to MiFID-RTS 6
Within the regulatory framework established by MiFID II, Regulatory Technical Standard 6 (RTS 6) plays a crucial role in preventing and managing disorderly market scenarios. MiFID II was designed to strengthen market integrity and mitigate systemic risks, particularly those associated with algorithmic trading. Through RTS 6, MiFID II specifies the regulatory obligations that investment firms must meet to ensure their algorithmic trading strategies function correctly, even under stressed market conditions and do not create or contribute to disorderly market conditions.
A "disorderly" market is characterised by behaviours that disrupt the natural balance of supply and demand, causing instability. This can result not only from technological malfunctions but also from poorly designed algorithms; or an algorithm’s inability to respond adequately to exceptional or stressful market conditions.
To mitigate these risks, RTS 6 requires investment firms to establish and implement clear methodologies for developing, testing, and validating their trading algorithms. Tests must be conducted in dedicated environments, separate from production environments, to avoid interference with real markets (Article 7). These environments may be internal or one provided by a trading venue or vendor.
Testing systems must be capable of simulating real market conditions, both stable and disorderly. This allows for evaluating the algorithm’s behaviour in adverse events such as drastic price movements, excessive volatility, or limited liquidity.
Additionally, firms are required to conduct periodic validation of their algorithmic strategies and related systems. This validation must include a performance review under both orderly and disorderly market conditions, along with a report demonstrating regulatory compliance.
Through these measures, RTS 6 aims to ensure that algorithms are robust and ready to react to unexpected situations so that markets maintain their integrity, avoiding episodes of high volatility or manipulation. This, in turn, helps investors maintain confidence in financial markets even during periods of turbulence and ensures that algorithmic trading − now an essential element of financial markets − is not considered a risk factor.
To assist investment firms in meeting the requirements of RTS 6, Euronext has developed Regpath, an integrated solution that provides a comprehensive framework for testing and validating trading algorithms.
Figure 4 - Regpath high-level architecture view – Source: Euronext
In accordance with the RTS 6 guidelines for investment firms engaged in algorithmic trading, Regpath integrates the bank's existing algorithmic trading solution with an independent, production-like ecosystem that allows for testing and validating algorithms on different trading venues. Regpath offers flexible integration, functioning both as a standalone system that connects to an organisation's internal or third-party trading platforms, and as a module within the Euronext trading suite. This versatility adapts to various operational setups, ensuring that companies can adopt the solution without having to completely overhaul their existing systems.
Distributed both on-premises and as a SaaS managed by Euronext Technology Services, the solution leverages Euronext's multi-asset trading technology to provide an independent means for executing test scenarios, helping companies refine their algorithm development processes and risk controls.
The platform supports testing across multiple asset classes, allowing companies to evaluate their trading algorithms independently of the methodologies used for their development. This ensures impartial evaluation and compliance with regulatory standards, as required by RTS 6. By emulating the protocols of different trading venues, Regpath enables the trading platform to interact as if it were connected to real markets. This feature facilitates realistic test scenarios, crucial for assessing algorithm performance under diverse market conditions.
Furthermore, Regpath creates a completely abstract environment where different market participant behaviours can be simulated, generating disordered market conditions. This capability allows users to configure market emulators, manage test scenarios that simulate both orderly and disorderly market conditions, and generate reports to demonstrate algorithm resilience and compliance − Table 1 lists the available scenarios for bonds. This is done in total independence from the trading system, allowing algorithms to be tested within their target platforms, ensuring compatibility, transparency, and adherence to regulatory standards.
Table 1 - Test scenarios available in Regpath for Bonds - Source: Euronext
References:
[1] The ESM electronic bond trading - Robin Wigglesworth, December 2024
www.ft.com/content/78851a71-c3be-40cb-91ca-95dd9f5a1e0b
[2] Credit trading finally exits the Dark Ages, April 2023
www.ft.com/content/8d30cdd3-cd5d-44c4-8ef2-b83ba62df295
[3] ESMA - Article 17 Algorithmic trading
www.esma.europa.eu/publications-and-data/interactive-single-rulebook/mi…
[4] Final report Benchmarks RTS
www.esma.europa.eu/document/final-reportbenchmarksrts
[5] MiFID II Review Report, 2021
www.esma.europa.eu/sites/default/files/library/esma70-156-4572_mifid_ii… algorithmic_trading.pdf
[6] Algorithmic trading: discover Algorithmicpath | Euronext
www.euronext.com/en/technology/trading-solutions/algorithmicpath-for-tr…
[7] Euronext Data Center
www.euronext.com/en/technology/euronext-data-centre
[8] Regpath | Euronext
www.euronext.com/en/technology/trading-solutions/regpath