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BlackRock Is Getting Into The Bond-Trading And Adverse Selection Businesses

What are you planning to buy from BlackRock? They have bonds for you:

BlackRock Inc. is planning to launch a trading platform this year that would let the world’s largest money manager and its peers bypass Wall Street and trade bonds directly with one another. … The trading platform would be run by the New York-based company’s BlackRock Solutions arm and offer 46 clients—including sovereign-wealth funds, insurance companies and other money managers—the ability to trade in corporate bonds, mortgage securities and other assets, company executives say.

Under the plan, the platform would seek to match buyers and sellers of the same securities, in a process known as “crossing trades.” BlackRock Solutions would charge a small fee for the service that would be much lower than Wall Street’s trading commissions.

Some of the transactions would effectively cut out the Wall Street dealers that have long acted as middlemen in the credit markets. BlackRock’s asset business, which oversees $3.5 trillion, would also use the platform.

So why wouldn’t you use this thing, whose working title is “Aladdin Trading Network”?* It’s pretty tautological that if you can cross a bond with another investor at a price that, with BlackRock’s small fee, is inside the market that you can get from dealers, you should do that. And presumably BlackRock’s $3.5 trillion AUM, plus whatever its clients post on this platform, provides a good opportunity for crossing. And from the Journal article there seems to be plenty of low-hanging fruit, e.g. BlackRock’s own funds only cross about 3% of their trades and are aiming to move that to 6-8%, so presumably that is possible in the basic sense that 6-8% of its trades are matchable with each other, so in a perfect-information world it’s kind of weird they’re not matching those already.

Of course the answer to why you wouldn’t use this is that there are so many bonds each of which is special in its own way, and you have your little heart set on a particular bond that is green with pink polka-dots and will accept no substitutes, and BlackRock either doesn’t have the one you covet or doesn’t want to part with it and neither do the 46 other folks on the system and so you have no choice but to source it from a dealer who will charge you a big nasty spread. Actually BlackRock will facilitate that for you too, which is perhaps a clue about how robust the matching will be:

The firm also has been in talks with Wall Street dealers, which may provide price quotes to the system. The banks also could be called upon to respond to orders that can’t be matched directly between investment firms.

You can be sort of pessimistic about this thing’s ability to cannibalize Wall Street on the usual mutual-coincidence-of-wants grounds: corporate bonds are relatively illiquid and there are just so dang many different kinds of them, so what are the odds that a buyer and seller of the same amount of the same kind come to market in the very same microsecond or for that matter day? And as Joe Cotterrill points out this sort of crossing system has been discussed – by BlackRock – for a while with pretty meh results. So you can continue being pretty meh about Aladdin.

The case for being optimistic, though, is along the lines of mumble mumble mumble Volcker Rule. The Journal notes that dealer bond inventories are down 70% in the last five years, presumably due mostly to economic risk-off decisions; the Volcker Rule’s likely restrictions on market-making – limiting dealers to reasonably related to expected customer demand, etc. etc. – should cut that further. Instant liquidity from a dealer is a real service that is perhaps worth paying a spread for, but if your dealer is slashing inventories and can’t provide instant liquidity, I’m not sure leaving an order for a dealer to work is obviously better than leaving it for BlackRock’s magically named magical system to cross automatically but next week.

If Aladdin sort-of works, though, it seems like it would lead to an adversely selected world. Very liquid bonds will cross between institutions – why pay a spread to buy or sell a bond that trades many times a day and that you can be pretty confident of crossing quickly and efficiently? Less liquid bonds – well, if you’re idly curious about the price you can get but are in no rush, maybe you’ll post them on Aladdin and wait a week. If you’re axed to sell, though, you’ll be willing to pay a dealer’s spread to get rid of them. Extrapolate from that and you get a world where dealer inventory notionals are decreased by the Volcker Rule, but risks don’t decrease much because the bonds that require market-making are sort of by definition the least liquid ones, and at least plausibly the riskiest ones.

If I were a regulator with a deep and abiding interest in promoting the aims of the Volcker Rule, whatever they are, I guess I’d be doing things like encouraging non-BHC-owned broker-dealers and hedge funds and whatevers to get into the market-making business so as to shift some inventory risk from government-quasi-backstopped banks to small-enough-to-fail non-deposit-taking nonbanks. My goal might be able to shift a cross-section of inventory risk from the banks to the nonbanks; in fact, I’d expect the spivvier risk to move to the nonbanks as small firms are more likely to want to make markets in $40mm bond issues of $500mm TEV private companies. Shifting the best inventory risks away from banks and into BlackRock’s Aladdin seems, on the other hand, like a less attractive way to go.

BlackRock’s Street Shortcut [WSJ]
Aladdin’s bond cave [FTAV]

* Because BlackRock will be front-running you? Meh.

126 comments
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126 Responses to “BlackRock Is Getting Into The Bond-Trading And Adverse Selection Businesses”

  1. Sabine says:

    TLDR

    – I do that laptime in a van

  2. Guest says:

    Since Matt usually doesn't have his tomes prepared by this hour, I assumed this was Bess until I came across 'tauntological'.

  3. diamondintherough says:

    Very interested in finding out where this trading network is located.

    -Jafar

  4. Guest says:

    My name is Matt. I am a robot. I have a robot vagina

  5. PermaGuestII says:

    Serious q- what's the difference between this thing and MarketAxess?

    • Guest says:

      on market axess you're still going through a dealer as a middleman. this proposed system would eliminate the dealer and customers would trade directly with each other.

  6. CondoFlip . com says:

    They should put Panic Buttons on the site ("for when you MUST sell"). That almost worked for us.

  7. dumb says:

    Levine, is that a photo of you in high school?

  8. Beerio says:

    I don't see this taking off to be honest – every dealer has a lot of electronic systems asking them to provide prices for clients already – Bloomberg, Market Axess, Tradeweb etc Another one, which just does the same thing, but lets other clients see the inquiry as well, doesn't seem like it's going to add value for the banks.
    For the clients – Presumably this thing is totally anonymous, but you still don't want to post lists of what you're trying to sell for all your competitors to see, so presumably it's also not something where you can look through bids/offers but instead have to put in your price for whatever specific bond you want to buy/sell and cross your fingers that there'll be a match. Also, does it tell you if there's someone offering but at a higher price than you want to buy? What if they're willing to sell cheaper than you're willing to buy? Split the difference?

    I'm a bond salesman. This doesn't scare me.

    • Guest says:

      Q: How do you tell when a bond salesman is lying?

    • PermaGuestII says:

      I'm a buy side fixed income guy at a middle-market shop. Color me sceptical. Highly doubt good ol' Lar is trying to cut everyone's commission payments out of the goodness of his own heart. #1 rule of this business is that fees never really get cut– they just morph into less visible form. I'd rather do business with a big sell-side firm that charges me a spread I can figure out– and provides other things into the bargain– than hand my axes over to someone who is basically trying to screw me in some invisible way.

      • Guest says:

        Mike Milken would love this.

      • agreatdaytothink says:

        Right. My dealers will know that if I come to them with a bond or if I put out a BWIC that I couldn't find a cross, so what's spread now? Not to good.

        Besides the couple of bonds in my space that trade daily (which already have a tight spread), I think I'm going to let the street screw me a little on all the bonds, that crush me on the ones I really want to move.

        • E. Texas Gas Trader says:

          The best thing about all of this is that everyone knows that in this day and age markets cannot be manipulated.

  9. Duder says:

    You know how some people look kind of dorky or bland or just plain odd until they smile and show a side to themselves that is truly heartening or endearing and you then think, wow, that person is a lot more attractive and full of character than I thought before they smiled and revealed his humanity? Larry Fink is not one of those people.

  10. guest says:

    What a great idea!

    Ghost of Bernie Cantor

  11. guest says:

    neither am i.

    john castle

  12. VonSloneker says:

    Assuming bond dealers aren't morons, they'll quickly distinguish between legitimate bid seeking activity and scrubs trying to set their cross price before rubbing Blackrock's magic lamp. Once dealers figure it out and stop providing free price discovery, won't Aladin just be a smaller, less efficient version of what we have now?

    – Admittedly not a bond guy

    • gab says:

      Depends on how illiquid or unusual the bond is. Dealers can't really "stop providing free price discovery." Price discovery is what they do, and there's always someone else to do it.

      • Guest says:

        Actually they can stop completely, see also 2008. Or when pressed, make the market 20-50 on AAA asset backed (non-sub prime). This happened.

        • PermaGuestII says:

          ^ this

          -Guy who remembers being quoted a 5 point dollar bid/ask spread on 3yr Boeing sr unsubordinated in Sep '08.

  13. I Miss the 90s says:

    Looks like an extra from Soundgarden's Black Hole Sun video.

  14. Confused says:

    Re: the footnoted comment

    Because the dealer you currently provide that information to now would never, EVER frontrun you or pass that information to people trading for the dealer's own P&L. Right?

  15. JohnB says:

    Show me the list of 46.

  16. equities says:

    I'll take hidden and advanced order types for a gajillion, Alex.

    -50 different US Equities trading venues

  17. Chris says:

    Here's another point nobody has mentioned. It mentions nowhere the participants will be anonymous so technically everyone will know who owns the bonds. Just a thought.

    • Been there before says:

      It has to be anonymous, but everyone knows who owns anything of size out there. Won't work anyway. Buy side is full of risk capital takers, not market makers. Street will see very clearly if you attempt to deal away, and God help you if you don't succeed in clearing the trade on Aladin and are forced back to the sell side dealers. Also, fixed income is a terrible recipe for an exchange model; 4mm+ descriptions and maybe 4-500 decent sized players on any given day vs. equities at around 12,000 listings and millions of investors.

  18. Guestest says:

    nice mugshot. Jenny McCarthy's future, possibly.

  19. HFguy says:

    BlackRock’s own funds only cross about 3% of their trades and are aiming to move that to 6-8%, so presumably that is possible in the basic sense that 6-8% of its trades are matchable with each other, so in a perfect-information world it’s kind of weird they’re not matching those already.

    — They are not doing this already since each fund or ETF is a separate legal structure and by MIFID rules, they need to find the best price so they have to go to the market for best price and once you find that price, you can choose to match with each other or with your own funds at that or lower price. Also bond trading is done on basis of price, there is no commission per say (if you know what I mean).. they are just trying to automate this process for themselves (read for their ETFs more than the funds) and once they have spent money on building this expensive software, they are openign it make money of it to fund it. Many IBDs are know for spin offs in similiar tech where they still are shareholders, dark pools are another example of same.

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