

Direct Match (YC W15) Aims to Make Bond Trading as Easy as Stock Trading - prostoalex
http://techcrunch.com/2015/02/15/yc-startup-direct-match-aims-to-make-bond-trading-as-easy-as-stock-trading/?ncid=rss&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+Techcrunch+%28TechCrunch%29

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lordnacho
Wow, as a former fixed income trader I find this really interesting. I wonder
if they're looking for any help.

There's definitely an issue with getting prices in the FI market. When I was
doing it, I used to create a Bloomberg chat with all the likely banks (the
usual suspects) and blast them all a message like "EUR 2Y, 1MM/bp, what's your
market?". And then wait as some guys were inevitably slower than others, and
some people wanted to pull their prices before I got them all. And the more
complex the product, the longer it took (swaptions for instance). And of
course once you'd picked someone to trade with, everyone wanted to know what
price it was. It was a real nightmare.

The question is how exactly this service is going to work. In principle, it's
not that hard to distribute prices, especially if they're not actually
tradeable like equities (then it gets hard!). I think I've seen at least one
service that just gives you an indicative and tells you who to call. These
days you could just do a filter with the banks you have docs with, and click
and chat with whoever came out on top.

Implementation wise, I'd worry if the banks made it too hard to integrate with
them. Even opening a firewall is something that can take time at big shops.

There's also a whole regulatory can of worms. Best execution, and all its
consequences.

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otoburb
>Unlike the stock market, the bond market doesn’t have a centralized system
where traders can plainly see the fees involved in the trade. This means
traders have to ask each bank, one by one, either by phone or electronically,
what they are willing to sell a Treasury bond for.

Mind. Blown. I always just vaguely figured that something as large as fixed
income / debt markets, which look to be at least twice as large as equity
markets[1], would have massive incentives for fintech to innovate much
earlier.

[1] [http://finance.zacks.com/bond-market-size-vs-stock-market-
si...](http://finance.zacks.com/bond-market-size-vs-stock-market-
size-5863.html)

~~~
jim_greco
Founder here. I find it crazy that over 50% of transactions in Treasuries and
70-90% in other asset classes are still traded over the phone. Lots of room
for new entrants to make an impact in the space.

~~~
ipsin
What's the case for small investors to buy bonds?

So I feel barely competent to purchase stocks, because there's honestly a lot
of crystal ball holding involved. Is the company going to grow? Is that
already priced in? Etc.

It seems like bonds are case where the returns will be paltry or risky, and
when risk is involved, the small investor will be least good at measuring that
risk.

~~~
nandemo
There are 2 ways to read your question.

1) What's the case for small investors to buy bonds, whether by buying them
directly or via a bond fund? In this case, I recommend reading up on Modern
Portfolio Theory and Asset Allocation or, if you just want practical
information, just get a basic book like the Bogleheads guide.

Basically, since stocks are risky, investors typically hold a combination of
bonds and stocks. Also, because the returns for bonds and stocks are
(somewhat) uncorrelated, a portfolio with a mix of bonds and stocks can have
better returns with less risk (variance) than a 100% stock portfolio. Assuming
your bond and stock holdings are diversified (e.g. you buy and hold index
funds), the main long-term investing decision you have to make is the % you
allocate to bonds and stocks.

2) What's the case for small investors to buy individual bonds instead of just
investing in a bond index fund? Well, depending on where you are, you can buy
government bonds without brokerage fees, so your costs might be lower. But in
that case it's harder to invest the coupons by yourself.

Of course bond returns are lower, but the risk is much lower too. In the case
of short-term bonds issued by most developed countries, the risk of default is
extremely small. The main risk is that unexpected inflation eats your returns.

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lmg643
I spent a few hours with a firm active in this space the other week. I think
this is going to be a difficult battle. There are already over a dozen
electronic venues for bond trading, some of which are pretty successful and
allied with major liquidity providers.

The core problem they are trying to solve is an example of something being
broken by design:

>>> "the bond market doesn’t have a centralized system where traders can
plainly see the fees involved in the trade. This means traders have to ask
each bank, one by one, either by phone or electronically, what they are
willing to sell a Treasury bond for."

This isn't exactly true - there are plenty of electronic quotes for small
size. When you want to trade a lot of bonds - that's another story. The
dealers don't want their prices out there electronically for any taker,
because fixed income markets are relatively illiquid and the transparency can
hurt them.

Not exactly sure how this will be overcome, but my general assumption is to
borrow from the dark pool model for equities.

~~~
galen211
Thanks - we chose Treasuries because it's a highly liquid market, and the
bonds are easy to value. Even large trades can't move prices by that much
since the cash flows of Treasuries are fungible. Also, the current electronic
systems for trading aren't necessarily good at accommodating large trades from
institutional investors. The entire risk of the trade is owned by one market-
maker. If trading platforms could facilitate one-to-many counterparty
transactions, the market would be able to price large trades more
competitively. Moreover, institutional investors could split up large trades
into smaller executions without disclosing their identity to a principal
market-maker. That might be more advantageous than executing a single block.

~~~
jbapple
> Even large trades can't move prices by that much since the cash flows of
> Treasuries are fungible.

Could you elaborate?

~~~
galen211
Sure - if you own a bond maturing in 10yrs and paying a coupon of 2% yearly,
what you have is a series of cash flows of 2 2 2 2 2 ... 102. In other words,
a treasury bond can be decomposed into a series of zero coupon cash flows
(interest payments+principal re-payment). The price of a 'whole bond' is the
sum of the prices of the different zero coupon cash flows.

A bond maturing in 30yrs has at least 10yrs of cash flows that line up with
the 10yr bond. Since coupon interest payments can be 'stripped' from one bond
and 'reconstituted' in another bond through the federal reserve, the price of
matched-maturity zero coupon cash flows, even if they are stripped from
different bonds, is the same. If they weren't, there would be an arbitrage
opportunity to buy the cash flows of one bond and sell the cash flows of
another bond, exchange them at the Fed, and lock in an immediate profit.
Sometimes arbitrage opportunities like this do exist, but typically it's due
to liquidity events where it becomes impossible finance offsetting positions.
There's a good article on this called "Notes on Bonds: Liquidity at all Costs
in the Great Recession" by Musto, Nini, and Schwarz

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jackgavigan
It'll be a tough market to crack, largely due to its fragmented and illiquid
nature (not to mention the structure that results from the role of the primary
dealers). It _might_ be the right time, with the regulatory restrictions being
placed on the big/primary dealers' prop-ish market making activities but if
the market does shift in the right direction for Direct Match (i.e. if
liquidity shifts away from the primary dealers, if they agree to partake in a
CLOB, or if, God forbid, the Treasury forces them to quote electronically,
like the European governments do with MTS), I'd expect the existing players
like NASDAQ and TradeWeb to be standing ready to jump in.

It's one of these markets that looks simple at first but there are lots of
nuances that have caused it to take the shape it currently has. To be
successful, I think Direct Match will need to do something a bit different
than simply offering a CLOB.

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pacofvf
>Unlike the stock market, the bond market doesn’t have a centralized system
where traders can plainly see the fees involved in the trade.

I thought that, that marketplace is the bloomberg chat embedded in the
bloomberg terminal, and IMO it's working good enough for big banks, I
understand that lowering the barrier entry for FI will bring more liquidity
but it's going to be a tough sell for big banks, which have >90% bond trading
marketshare .

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noname123
Tangential question, for retailer traders out there, how do you guys buy
bonds?

I think the typical way is to buy TLT ETF which is very liquid. But I'm
curious if you guys tried any retail brokerage way of buying and holding onto
treasuries directly or even if it's worth it.

