Direct Match is a FINRA-registered broker dealer that recently announced plans to offer an all-to-all electronic trading platform for US Treasuries later this year – the first of its kind. JLN spoke with Jim Greco, the company’s CEO and co-founder, and William O’Brien, its new executive chairman, about the why and the how of the new platform.
Q: How did the idea of founding Direct Match come about?
Jim: I’ve been involved in the markets for a long time, on different sides. I worked for Getco and built the platform KCG Acknowledge, which was a bilateral streaming platform for trading US Treasuries. I was also a Treasury trader. I saw the deterioration in my ability to make markets with interdealer brokers.
After the merger of Getco and Knight Trading into KCG, I spent time at the primary dealer Jefferies, where I saw the pain points for the other side of the coin as a dealer both sourcing and providing liquidity. Customers, too, were frustrated by the market. When I left to found Direct Match I wanted to do something different that brought these constituents together. At that time proprietary firms were providing the most liquidity. I wanted to get them together with the buy-side institutions in a single pool. There was overlap between proprietary trading firms, who are the primary liquidity providers in the market today, bank dealers who traditionally provided liquidity to the buy-side institutions and who are still major players, and buy-side institutions – asset managers, hedge funds, and Chicago trading firms.
Q: Why is there currently no centralized exchange for the trading of Treasury bonds?
Jim: The market has historically been bifurcated – a dealer to dealer market where bank dealers have gone to lay off risk. About 10 years ago prop trading firms like Getco were trying to get into the market. Separate from that pool is the dealer to customer market, which is entirely a bilateral market between bank dealers and buyside institutions and is done about 62 percent over the phone, whereas the dealer-to-dealer market has gone entirely electronic.
There have been a lot of regulatory changes in the past five years that put pressure on different constituents in the industry. In particular, making markets in Treasuries or any fixed income product is a very balance sheet intensive operation. Dodd-Frank and other recent regulations dramatically increased the costs to hold that balance sheet. That has really changed the game. Similar things have been happening in corporate bonds – going from largely a principal liquidity provision game to more of an agency model. That’s not quite what’s happening in Treasuries, but the old way of liquidity provision has become less effective and efficient.
Q: Why is there a lack of transparency in that market?
Bill: The dealer-to-customer market has continued to be largely over the phone, and there is no notion of market-wide transparency in a market that’s point to point. Even the dealer market has been largely dominated by closed pools, which are very selective on who can trade there, and there is not a lot of transparency as to the criteria for choosing participants.
When people see the 10-year bond quoted on any financial news network, they are seeing a price quote not for the cash market but for the futures market, which is far more transparent than the actual cash market. Imagine if you could only know at what price Apple futures are trading. In the legacy market structure, the buy side could rely on liquidity providers as long as they had relationships with several traditional dealers, but the nature of liquidity is shifting, and prop firms as well as the buy side are struggling with a lack of transparency. That dictates the need for a true all-to-all platform.
Jim: The Direct Match market is a CLOB at its core. It should look similar to how an equities or a futures exchange is set up. You post an order, a quote that is completely public to all participants, and before you transact you know exactly what the cost will be and the exact price. Everyone trades anonymously, with direct matching, and the clearing facility stands between every trade.
This will be the first time buy side investors will be able to directly participate in price discovery. The platform allows them to take liquidity but also to participate in providing liquidity.
Q: Will the market be integrated with the futures market?
Bill: We are a venue for cash liquidity only, so we won’t interact with the futures markets.
Q: What would happen to the markets if the Treasury implements a rule that trades in Treasuries will have to be reported?
Jim: The Treasury and other regulators are definitely interested in introducing transparency and in assessing which data should be public, in particular focusing on pre- and post-trade transparency. The regulation comes in various forms, from heavily regulated, as in the equity markets, to other markets that encourage transparency through competition.
Bill: The Treasury market has unique features and always will, but at the same time there are parallels today with the equity market structure 10 to 15 years ago, when it was partially electronic and bifurcated between providers and demanders of liquidity. Historically, regulators have focused on the stock market first because there was a more direct connection to the individual investor. But whether you are talking about changes to the capital rules since the financial crisis, the market shock of October 2014 and the volatility seen at the time, regulators are focused not necessarily on replicating market structures but on learning from the evolution of other markets in order to make them operate better for all constituents, including the issuer, the United States. In the bond market there is just one issuer, and we all want to be long it.
Q: Do you foresee any adverse effects to the Treasury market from the regulations?
Jim: In the Treasury market there is a broader panoply of regulators – the Treasury Department, the Federal Reserve, the CFTC and the SEC – who have worked together to raise awareness and solicit opinions on these issues to improve the market. I think that will be a force for positive change.