By Bradley Hope And Katy Burne
Investment Technology Group Inc. is jumping into the race to
solve one of the trickiest problems for big investors: finding a
better way to trade bonds now that banks have stepped back from the
business.
The New York-based brokerage and technology firm said Wednesday
that it is planning to launch a trading venue known as a dark pool,
a private platform in which buyers and sellers remain anonymous.
While most bond trading takes place over the telephone between
dealer banks and customers, ITG and a host of others are trying to
tap into increasing demand from fixed-income investors to trade
more cheaply and through electronic networks.
The credit market has, until recently, resisted the incursion of
fully electronic trading more so than markets for currencies,
stocks and some derivatives.
Similar efforts by firms such as Goldman Sachs Group Inc. and
BlackRock Inc. have faltered, but ITG is betting it can leverage
its track record in stock trading and technology to make inroads
into credit markets. One of its chief rivals, Liquidnet Holdings
Inc., announced in March it would open its own credit-trading
network in the fall.
Liquidnet didn't immediately respond to a request for
SHYcomment.
Goldman and BlackRock still operate their platforms.
ITG is starting with a test version of the venue, called Posit
FI, in October, and it will become fully operational as a dark pool
by the end of the year. It goes up against roughly a dozen
electronic-trading venues for bonds trying to cash in on what
financial institutions expect to be a lucrative transformation in
the $10 trillion corporate-bond SHYmarket.
The venue will allow investors to trade bonds using frequently
updated prices.
"Investors have complained to us about the difficulty trading
bonds and transparency in pricing," said Jamie Selway, managing
director at ITG. "We think this is going to solve some of those
problems and add SHYliquidity."
Still, some see hurdles ahead.
The idea of using dark pools for bond trading is sound but the
practicalities of getting it off the ground are hard to surmount,
said Anthony Perotta, head of fixed-income research at Tabb
Group.
"I don't think, at this point, there will be enough situations
where there is another side of a trade," he said. "When you're
selling, there's probably a reason you're selling, and your
like-minded brethren are doing the same."
Since the financial crisis, investors have said it is
increasingly difficult and expensive to quickly trade bonds,
especially in large sizes.
Large trades start at about $1 million in bonds and
market-moving-size trades from about $5 million. ITG is focusing on
handling trades between those amounts.
Investors blame the problem on a pullback by dealer banks that
traditionally acted as middlemen in the market. Dealer banks have
scaled back their fixed-income trading because of stricter capital
requirements imposed by regulators after the financial crisis.
"There is so much fragmentation in the corporate-bond market,
and dealer inventories are going down," said Chris Rice, global
head of trading at State Street Global Advisors in Boston. "We're
interested in any way we can to create links in the bond ecosystem
that will increase the efficiency of trading."
Analysts have pointed to the potential for growth in the
electronic trading of bonds. Among the options for credit markets
are dark pools, which have become a force in stock trading over the
past decade, accounting for roughly 14% of all trades, according to
Tabb Group.
ITG ultimately hopes to draw on an approach it has taken in
stocks by directly tapping into the order-management systems of
traders to let them know when there are willing sellers or buyers
in the market for specific bonds.
Change in the bond market has been slower than anticipated,
however, causing some previous efforts to sputter and startups to
be gobbled up by better-capitalized or more-established platform
providers.
ITG's approach is probably slightly early in the market's
evolution, said Frank DiMarco director of fixed-income electronic
brokerage at ITG. But he said investors are looking for ways to
trade more actively ahead of an expected rise in interest rates
next year.
Posit FI has some of the features investors have found useful in
other attempts, including allowing firms to trade either on prices
broadcast regularly throughout the day or in predetermined time
slots or sessions, similar to the GSessions platform brought to
market by Goldman Sachs.
Many investors ultimately felt GSessions and other
single-dealer-owned systems wouldn't put their own interests first
and have pushed for an independent solution. Goldman Sachs declined
to comment.
Others that have pursued channels to facilitate
investor-to-investor trading include MarketAxess Holdings Inc.,
which handles much of the electronically traded corporate bonds in
the U.S.
The ITG system also proposes to offer customers prices updated
every minute on 14,000 corporate bonds, of which less than half
would be for securities that don't frequently trade. That pricing
information is seen as helping juice trading by customers who are
used to calling around dealers for prices before they make a
transaction.
The pretrade pricing effort comes at a time when the Securities
and Exchange Commission wants to make prices on both municipal and
corporate bonds more widely available to SHYinvestors.
ITG has been in talks with a few dealers about participating on
the platform, but the company said it doesn't view their
involvement as critical, because the goal is to bring customers
together in an environment that is cost-effective even without
dealers.
Write to Bradley Hope at bradley.hope@wsj.com and Katy Burne at
katy.burne@wsj.com
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