Institutional investors, including mutual fund managers,
will be able to lend their bonds to Wall Street and help
fixed-income trading markets get moving again, once a new
electronic platform becomes available next year. Thats
the idea behind DelphX, a communications network that will
allow Wall Street banks to get around regulators
restrictions on their securities inventories, essentially
renting positions from investors to support trading. By
renting, not owning, banks wont have to put up expensive
capital to facilitate market making.
Larry Fondren, founder and CEO of Malvern,
Pennsylvaniabased DelphX, expects the product to go live
in the first quarter of 2016. Wall Street, big bond investors
and regulators have been painting a picture of broken trading
markets and the potential for a crisis to erupt once interest
rates start moving up and bond prices fall. But the difficulty
big investors are having buying and selling large blocks of
bonds has also created enticing opportunities for eager
entrepreneurs like DelphX.
DelphXs idea leverages an indisputable fact: Wall
Streets bond holdings have shrunk 80 percent, by some
estimates, since the highs in 2007. At the same time,
corporations have issued record amounts of debt to take
advantage of record-low interest rates. Investors searching for
higher-yielding securities have gorged on the new bond issues.
Total assets in high-yield mutual funds alone have grown to
$286 billion, up from $176 billion four years ago, according to
Chicago-based fund tracker Morningstar.
Fondren says that the companys platform is an
electronic trading network that allows banks to negotiate
future deals with investors and then place a hold on specific
securities through DelphX. The securities that are covered by
the contractual agreement are called cached inventory. Through
DelphX, banks can get access to the securities to fulfill the
transaction within a specified time period. Dealers set
up pools of reserved inventory this way, but theyre not
on the dealers balance sheet, says Fondren.
Conversely, investors get incentives to do the transaction.
Investors get alpha by allowing the dealers to place a
hold on their securities, he adds.
In the 1990s Fondren developed and operated InterVest, the
first regulated market for electronic trading of corporate
bonds and asset-backed securities.
As an example: A dealer may offer insurance companies, which
are some of the most regular buyers of corporate bonds, a
better price on popular new issues in return for the right to
buy the security back at a higher price some time in the
future. The transaction would give the insurance company access
to new bonds and the dealer a potential inventory to sell if
markets become more favorable. In many ways the insurance
company would be passively making markets, adds Fondren.
DelphX holds all cached inventory in its system confidentially.
Before banks became subject to increased capital charges and
other restrictions on proprietary trading, they would have held
back part of a new issue for their own trading books, hoping
the price would rise and then selling the securities into the
Fondren says, Weve given dealers back the
ability to intermediate liquidity. They dont buy and
hold. Dealers buy in order to sell. He adds, Bond
inventory has to move, just like product in a hardware
Kevin McPartland, principal of market structure and
technology at Greenwich Associates in Stamford, Connecticut,
says, If this alleviates the balance-sheet concerns on
the sell side, then this could be a huge deal. McPartland
notes that there are issues still to be worked out with cached
inventory, such as regulators take on the agreements,
but nothing that is insurmountable. Everybody is trying
to adapt to the new world.
McPartland, who authored a recent study on the
state of electronic trading of corporate bonds, emphasized
that new entrants are seeing a respectable level of success in
breaking into the fixed-income market.
Although a number of innovations are relying on changes in
the way the market is structured, DelphXs platform keeps
participants playing familiar roles. All-to-all
trading protocols, for instance, allow a bond manager to
connect with a competing firm to find the other side of a
trade. But money managers have long relied on intermediaries to
support their trading needs, and behavioral changes could be
far down the road. With DelphXs platform, a dealer who
gets a call from a big client looking for a $50 million
position, say, can then put out multiple caching offers to
investors who may hold the security. The dealer gets the
ability to structure inventory held on the balance sheets of
Investors are selling off some of their upside for a
limited period of time, says Brad Golding, a New
Yorkbased managing director and portfolio manager at
Christofferson, Robb & Co., a global credit money
Rick Perretti, an executive vice president formerly at
Dallas-based Southwest Securities in taxable fixed income who
recently joined a credit hedge fund, says DelphX is innovative
on a number of fronts, including its plan to turn fee protocols
on their head. Instead of charging dealers for every
transaction they execute through the platform, DelphX will
charge a monthly fee to money managers for unlimited trades.
The fee structure will encourage more dealers to sign on,
especially regional brokerage firms. Regionals operate
most efficiently with smaller insurance companies and other
accounts. If you combine their model with DelphX, regional
dealers can start to move up, solicit larger money managers and
play a larger role in the market. There needs to be some
solutions that can unclog this drain, he says.
Golding says the concept of charging money managers is
reasonable in theory, especially if dealers are likely to show
prices on day one because of the pricing structure.
Investors are complaining about liquidity. This gives
them an innovative platform that could help them in a
crisis, he argues. DelphX allows dealers to quickly
move bonds off their balance sheets and still have inventory
for their sales and marketing people to work with.
Not everybody thinks electronic trading platforms and other
solutions will fix problems that have popped up in bond
markets. Marc Pinto, a managing director in the financial
institutions group at Moodys Investors Service, says,
These only help at the margins. But despite all the
chatter in the market about the lack of liquidity, Moodys
doesnt think a crisis is waiting to happen. Robard
Williams, a vice president and senior credit officer at
Moodys, thinks market structure will ultimately work.
As market volatility picks up and as investment clients
demand it, banks will be there. If the return is there, they
will participate, he says.
Follow Julie Segal on Twitter at @julie_segal.
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