Who lost MTS? The Electronic Trading Platform Killed by JGB

Tomohiko Taniguchi (Editor-at-Large, Nikkei Business Publications, Inc.)

On October 31, an electronic trading platform for fixed income instruments ceased its Japanese operation almost unnoticed. Its operator, MTS Japan Securities, will be liquidated and will disappear by mid November.

This exemplified yet again how distorted Japan's government bond (JGB) market is. Sovereign bonds are risk-free, hence they are supposed to serve as the basis on which all the other financial risks are measured. When it is hard to locate the North Pole Star, as it were, you are destined to become lost.

MTS, which in Italian stands for government bond market, was an invention of the once debt-laden nation of Italy. Born as a government entity, it was privatised when trading floors across the euro area went private under the directive of Brussels. Instead of the "voice call system" that relies on traders talking to each other via telephone, MTS provides market participants with a virtual trading floor where "bids" and "offers" for each bond are shown on PC screens. By dramatically simplifying trading activities, thereby reducing relevant fees, MTS has established itself as a de-facto standard platform throughout Europe for trading fixed income instruments.

Acknowledging its utility, governments in Europe have invested into the platform as debt issuers. Some have even seconded their officials to the operating companies, as is the case with MTS Portugal.

So in early 2002 when Gianluca Garbi, the then 31-year old CEO of the umbrella company MTS Europe came to Tokyo, it was a high point for him. But he would soon have had his day. MTS Japan would never take off.

Japan is by far the world's largest in its amount of sovereign debt issuance. Its total debt as against the GDP stands at a stunning 140%, a historical high for any developed nation. It would have seemed natural for an effective trading platform like MTS to succeed in such a market. Expecting success, even officials from the Ministry of Finance and the Bank of Japan rushed to give moral support, if not investment, to MTS Japan.

It turned out, however, that the JGB market was too savage for MTS to survive. I might even say too barbarous, were I to hear their inner-most voices.

For this system to function, it takes dedicated "market makers" who "make" the market by continuing to propose bids and offers between which they maintain a fixed differential (measured in basis points). This is to invite increased transactions and with them increased liquidity. What motivates them to do so is the fact that in most cases they are also "primary dealers", who are entitled to engage in daily conversations with the issuer, i.e., the government, and hence take at first hand the pulse of the financial authority. There has been talk for the last two years in Japan to foster such dealers, but it remained just talk. Soon the market makers on the MTS Japan platform would find themselves doing the impossible with no rewards expected.

The market makers for MTS Japan, who are also its major share holders, had to expose themselves on the trading floor for as prolonged a period as three and a half hours each and every day. They do so by continuing to quote bond prices.

This has proven fatal for them as since June this year, the JGB market has turned extremely volatile. Remember that Japan's long term interest rate suddenly soared, reflecting the bull run in the stock market.

In the preceding months, the total reverse was the case. People simply lost their appetite for trading extremely low-yield JGBs. In either case, MTS could not prove its utility, for in the first half, the market was too quiet whilst in the latter it was just the opposite, neither of which allowed MTS to generate sufficient commission revenues to sustain its operation.

So Mr. Garbi is probably shrugging his shoulders, saying that he should never have attempted to touch the soil of Japan, where even common sense does not apply.