>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.
The problem is that the market has been skewed by banks, which set-up the existing electronic platforms in the 1990's. The electronic trading protocols were designed to be exactly like a telephone conversation between the bank and its customer. By restricting who can 'listen' to the conversation, banks create a private information loop, where the largest banks with the most customers can capture more of the information in the market than other participants. Effectively, this advantage over the market means that investors have been subsidizing billions of dollars a year in bank profits for years.
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.
There's a big opportunity to put people's bid/ask on a single platform, but it's always tough to build a two-sided market. Are you concentrating on building supply or demand first? What's in it for the incumbents to use this platform? Doesn't the status quo benefit them? (I'm guessing less price transparency and less liquidity in the market translates to higher fees and margins)
The biggest change since the financial crisis is that the buy-side (mutual funds, hedge funds, pensions) is now in the driving seat for determining what the future of markets look like. We're seeing that with innovative new exchanges like IEX in the equities space.
We've built demand on the buy-side and are now reaching out to sell-side partners who are interested in moving the market forward. The parts of the sell-side that haven't invested in technology and are holding onto their old ways aren't very excited. The parts that have are a lot more open and we are looking forward to having them onboard on day one.
Ah great move. Capturing the scarce side of the market usually works unless there's some sort of market anomaly (legislation, etc). The platform sounds interesting and I'm working on a similar problem in a durables market. Would love to talk more on tactics offline if you're interested/available.
Every market usually has the problem of a lot of supply and little demand or a lot of demand and little supply. We were former US Treasury traders so we understood the part of the problem to best attack first. Other asset classes like corporate bonds are the opposite market dynamics and we are still figuring out the right approach.
Would love to connect. First initial last name at directmatchx.com
There's been a lot of concentration in assets under management among a few top buy-side institutions while dealers have reduced their risk tolerance/balance sheet and been displaced by electronic market makers, relative value hedge funds, and proprietary trading shops.
In many of the fixed income markets a lot of activities are still done over the phone or inter dealer voice systems. Tullet Prebon is one such company that facilitates these activities via a voice bus.
The questions come to mind are:
1. if you are providing a service to provide price feeds:
- for the on the runs, then places like retuters should be able to provide that data
- for off the runs, there is much less liquidity/information as mentioned here, for that a price is often paid to dealers (so no change there)
2. If you are creating an exchange then this can possibly reduce the spreads for less liquid instruments
- The interesting problem you'll need to deal with is how everyone deals with settlement.
Which other asset classes are you thinking of? I think that most transactions in cash equities, spot fx and futures are now done electronically.
I'm sure that a large proportion of derivative trades are still done over the phone, but that's because they tend to be (a) quite customizable and (b) quite hard to price.
It is incredible that treasuries are still traded over the phone, however, given how (relatively) easy they are to price. Even treasury futures, which are harder to price due to the basis and optionality, are mostly traded electronically, which tells me that there must be some parties with a pretty strong interest in keeping bond trading a "closed shop".
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.
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.
Diversification. Also, even if investors don't buy bonds, prices in the bond market still affect them. Treasuries represent the price of 'cash in the future' since they are risk-free assets. Everything from mortgage rates to the cost of credit for companies is fundamentally dependent on price discovery in the Treasuries market.
The market in general is not aimed at small investors, with some exceptions (governments usually have ways to buy their bonds, some tax freindly areas like munis in US are ok). Often minimum sizes are large, the documentation is complex, issues are all different, and so on.
aren't you being a little bit misleading here? brokertec and espeed exist and are available. Banks don't want to trade many of the illiquid bonds electronically, but the issue IS NOT lack of availability of electronic platforms where they could do it.
Brokertec and eSpeed are inter-dealer platforms. If you're an asset manager, pension fund, or even a central bank, you can't trade without going through a bank. The point is to create a market that treats investors the same as banks.
it's not entirely true, since HFT firms trade on them directly without going through a bank. The issue is there is no liquidity on these platforms for bonds other than on the run treasuries because banks don't want to provide it. Without banks providing it, there will be nothing for pension funds to trade.
here is from their website
"BrokerTec facilitates both API and manual trading for institutions, banks and non-bank professional trading organisations"
HFT firms can only access on-the-run trading currently. That doesn't mean the bank is responsible for all the liquidity in off-the-runs. It's just highly inefficient that intermediation has to occur via the swapbox, which isn't accessible to electronic market makers. There are plenty of relative value hedge funds that would take the other side of buy-side flows, if they had access to a market where they could show their trading intentions anonymously.
If Direct Match has enough success, what would stop ICAP/BrokerTec/eSpeed from allowing HFT firms to trade off-the-money and snatching back up the market?
Yes, you are correct. ICAP formerly BrokerTec allows large non-bank professionals to trade on their platform. However, what about the smaller entities or retail traders? The only option available to the small guy is either invest via mutual fund or buy ETF like TLT.
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...