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WITH RANK COMES PRIVILEGE. NO ONE KNOWS that better than Laurence Fink, the voluble chairman and CEO of BlackRock, the world’s largest asset management firm. In September, while one of his lieutenants, Richard Prager, was meeting with a reporter, Fink hovered near the door of Prager’s office for a few moments before stepping in and asking what they were talking about. Prager, BlackRock’s global head of trading, told his boss that he’d been explaining what the firm is doing to make sure it continues to thrive in markets that are undergoing some of the biggest changes in a generation in the wake of new regulations and the seemingly never-ending financial crisis.

That was all the opening the 59-year-old BlackRock CEO needed. Fink, whose love of power and showmanship is tempered by a child’s wide-eyed curiosity and energy, raced on about the forces shaping BlackRock’s plans. It was a long list: an inexorable macro trend toward less dollar–based trading, French banks stoking counterparty fears, investors pushing up costs by demanding more “granularity” on securities, and the need to create the right asset management culture to manage all of this. After his five-minute soliloquy, the indefatigable Fink left as swiftly as he had entered the room.

Fink, who has an outsize grasp on the details of his $9 billion-plus-in-revenue business, has reason to be worried. BlackRock is one of the largest managers of fixed-income securities and relies on unfettered access to them and to efficient capital markets to manage its growing portfolios for retail and institutional clients. A lack of sufficient liquidity — financial jargon that refers to the ease with which a trade can occur at a given price — has defined the debt markets off and on since 2007. In the years since the 2008–’09 crisis, as investment banks have moved to deleverage and governments around the world have imposed restrictions on banks as a result of the Basel III accord and the Dodd-Frank Wall Street Reform and Consumer Protection Act, there has simply been less liquidity sloshing around in the system. That means firms like BlackRock can’t buy and sell the securities they need as easily and investors aren’t getting the prices they want. Liquidity is likely to continue to be under pressure as governments debate regulations, the economic environment remains shaky and banks reduce trading risk.

Prager is only a small part of the story unfolding at BlackRock. Robert Kapito, the firm’s president, is the man behind the charge to redefine BlackRock’s every interaction with the capital markets, overseeing one of the biggest structural changes in how buy-side firms work with their counterparts on the sell side in 30 years. It’s in keeping with Kapito’s humble roots that he hasn’t broadcast his plans to the world. If Fink is the public, ubiquitous face of BlackRock, Kapito has fathered the intense culture within the firm.

BlackRock, with $3.3 trillion in assets under management, more than three times the size of its nearest competitor, is retooling the long-standing relationship among asset managers, investors, Wall Street and companies looking for capital — and changing the value proposition for its industry in the process. To combat the growing problems in fixed-income markets and the changing market structure of Wall Street, BlackRock is taking a seat at the table with banks and issuers, helping them design bond offerings and advising them on deals. The firm has launched a global capital markets desk, as well as a syndicate desk, hiring executives from Wall Street banks with the promise of bigger opportunities and greater riches. At the same time, BlackRock is aggressively expanding its electronic trading capabilities — developing another way to get the liquidity it needs — and building a securities crossing network to match buy and sell orders within the firm so it can bypass the Street altogether and save its clients millions of dollars in trading costs. By building a capital markets desk, BlackRock will be able to get better terms on the securities it buys and sells, larger allocations when it wants them and deeper information about the primary markets.

For the 54-year-old Kapito, one of the firm’s founders, BlackRock has no choice but to build these new capabilities. “Yields are low, interest rates are low, liquidity has changed,” he says. “We have to think differently to produce results for clients.”

Historically, the interactions among investment banks, corporate issuers, money managers and investors have followed a standard script. A bank would advise a company — say, Kraft Foods — on its capital structure; when it should issue debt and at what rate; and whether it should buy back stock or shore up the equity on its balance sheet. The bank would then structure and offer securities to money managers, which in turn would buy them for individual investors and institutions.

But Wall Street doesn’t have the resources it once did, and BlackRock doesn’t necessarily want to wait for banks to come to it with the choices on the menu. Instead, it wants to have a hand in designing the menu itself, helping to advise companies on their capital structure and how securities might be constructed. To do that, BlackRock has had to build capabilities that were once the sole province of investment banks. But Kapito and other senior executives at the firm are careful to point out that they are not trying to eliminate broker-dealers from the capital-raising process. They contend that it would be a mistake to try to replicate Wall Street’s high-cost infrastructure.

“We pioneered a capital markets capability not because we’re getting into the underwriting business; we’re not,” says Peter Fisher, 55, head of fixed-income portfolio management at BlackRock and former undersecretary for domestic finance at the U.S. Treasury. “But we do want to buy and hold the assets with the risk-return profile that we’re looking for — rather than just the ones on offer.”

BlackRock is the first mover in what will emerge as a new model for how business gets done between Wall Street and the rest of the financial industry, including money managers, which oversee trillions of dollars for retail investors and institutions such as public pension funds. Other asset managers ultimately will be forced to institute similar changes or risk losing ground.

“The big buy-side firms are displacing Wall Street,” says David Weild IV, who heads capital markets research at U.S.-based accounting and business advisory firm Grant Thornton.

BlackRock has grown substantially since Fink, Kapito and the six other founding partners spun out their business from private equity firm Blackstone Group in 1994 with $53 billion in mostly fixed-income assets under management. BlackRock now boasts more than 10,000 employees, operates in 27 countries and has expanded well beyond fixed income, which represents a little more than one third of its assets. The rest are spread among equities (44 percent), multiasset and advisory portfolios (10 percent), cash (7 percent) and alternatives (3 percent).

What hasn’t changed is BlackRock’s raison d’être: to build a firm whose interests would be aligned with those of its investors. Fink and company have maintained that mission through a series of acquisitions capped off in 2009 by the purchase of Barclays Global Investors, which made BlackRock the largest asset management firm in the world and put it neck and neck with Newport Beach, California–based Pacific Investment Management Co. in the race for the crown of biggest bond manager. 

“Rob and Larry have taken a firm from a handful of partners to more than 10,000 employees,” says Gregory Fleming, who runs the brokerage and asset management businesses at Morgan Stanley. “There are not many founder-entrepreneurs who have the skills to transition from launching a start-up to leading a global firm.”

In the wake of the 2008 market meltdown, global regulators have imposed higher capital requirements. Basel III, the global banking standard, increases the common equity that banks must hold and defines risk-weighted assets more onerously. It also dramatically increases capital requirements for banks’ trading books. The Dodd-Frank Wall Street Reform and Consumer Protection Act imposes additional burdens on banks’ business models and requires clearing of derivatives contracts. As banks are being forced to increase capital and reduce leverage and risk exposure, they have less desire to hold positions that their clients are buying and selling. As a result, big investors looking to sell anything from a corporate bond to a mortgage-backed security are driving down prices.

“In the current regulatory environment and because of the excesses, that pool [of Wall Street capital] has shrunk,” Kapito says. “So the leverage is going from 30-to-1 on its way to 8-to-1. The amount of balance sheet those firms have available to do those trades and to put positions on their books is just less.”

Primary dealer holdings of corporate bonds peaked before the credit crisis at about $240 billion. That number fell to about $55 billion during the crisis, recovered some in 2009, then dropped again, to about $65 billion recently, more than 70 percent off its high. “This pressure on primary dealer balance sheets becomes a strategic issue for investment managers because they aren’t seeing the same level of liquidity from the dealers that they did prior to the crisis,” says Richard McVey, CEO and chairman of MarketAxess, one of the dominant electronic trading networks for U.S. high-grade corporate, high-yield and other debt securities.

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