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MARKETS MEDIA JANUARY/FEBRUARY 2012 FEATURE

Credit Quality MarketAxess blazes a trail in the electronic trading of corporate bonds FEATURE

he dot-com bust of more than a decade ago left countless casualties, but survivors such as Amazon, eBay and Yahoo! have managed to not only stick Taround, but also change the rules of their respective games. A comparable success story in the financial space is MarketAxess, whose client-to- Client to multi-dealer multi-dealer trading platform allows institutional investors to request bids and offers electronic trading is now on corporate bonds from broker-dealers, and then pick and choose who to trade with. well-established in fixed “We are promoting price discovery, transparency and trading efficiency for the income and other less- institutional credit markets,” said Richard McVey, chief executive of MarketAxess. liquid asset classes. Corporate bonds have never been the most efficiently traded securities on Wall Street, as liquidity is comparatively low for all but the biggest names such as General Electric and Bank of America. “In an OTC market where we operate, you need to think of what’s going to drive investors to use the trading system and what will motivate dealers to make markets,” Auction-based systems McVey told Markets Media. “On the investor side, the value proposition was always promote transparency, to create a central trading place to promote transparency, competition and straight- competition, and openness through processing, while on the dealer side it’s about promoting broad client reach, in the swaps markets, which greater inventory turnover in trading books, and lower cost.” are the overriding objectives Prior to founding MarketAxess in 2000, McVey was managing director and head of of the Dodd-Frank Act. fixed income sales in North America at J.P. Morgan. In that role, he was responsible for developing and maintaining client relationships across all asset classes. clients initiate electronic orders and send them to dealers of their choice, who then compete for GOING ELECTRONIC those orders.” As the 21st century dawned, bond dealers were concerned that the Internet would The process is tailored for corporate bonds that disrupt their core business, i.e. squeeze bid-ask spreads and profit margins. But may trade just a few times per day. “Whereas it’s rather than resist the trend, some dealers moved to incubate and harness the tech- impossible for dealers to make live markets on nology to launch new businesses. tens of thousands of securities that trade infre- MarketAxess is a classic example. “At J.P. Morgan, we saw that fixed-income trad- quently, we provide liquidity on demand with ing would increasingly move electronic, and there was a strategic objective to use our auction-based system,” McVey said. “Cli- technology to expand client reach in a cost-effective way,” said McVey. “There were ents and dealers have both shown a preference 30 or 40 examples of companies incubated by the dealer community, and a handful for auction-based technology because it allows of them turned out to be successes.” them to cope with fragmentation in the corpo- In 2000, there was no meaningful electronic trading in corporate bonds. Trading rate-. The forward-looking oppor- took place bilaterally between dealers using telephone, e-mails and faxes to transmit data repositories) and CCPs (central counterparties) that tunity is that a large part of the market is still trading on the inventory and indicative prices; clients had to expend considerable manual effort to will require independent governance. This puts MarketAx- phone.” ess on a favorable footing vis-à-vis its competition, according to McVey. MARKET SHARE discern what bonds were available, and at what price. “Clients like the fact that we’re independent, that we are a MarketAxess has 900 active clients and “Getting 80 dealers on one system to aggregate inven- public company that can act objectively with respect to the 80 dealers making markets. In the fourth quarter of 2011, tory and prices and compete for order flow is a radi- best interests of both investors and dealers,” said McVey. MarketAxess’s share as a percentage of Finra's high-grade cal departure from the way the market worked before “Regulators like independence too. We already have that. We Trace trading volume was 12.2%, up from 9.6% in the year- 2000,” McVey said. went public in 2004, we have a fully independent board, and earlier period. We are promoting price The global bond market has an estimated aggregate our financials are public. Today, some of our competitors are MarketAxess' clientele includes investment advisers, mutual discovery, transparency and value of $95 trillion, so it comes as no surprise that the not independent, and that will be a differentiating factor in funds, insurance companies, pension funds, banks, and business of electronically trading bonds is highly com- the trading space going forward.” hedge funds. "Trading electronically on MarketAxess is an trading efficiency for the petitive. MarketAxess’ competitors include broker- Today’s fixed-income market is largely segmented by client efficient way to access the corporate bond markets and eas- institutional credit markets. dealers who trade with each other and with institutional focus: inter-dealer brokers such as BGC, ICAP and GFI operate ily reach a broader group of dealers," said Kerry Gawne, CFA, investors, as well as other multi-dealer trading firms trading venues within the dealer-to-dealer segment, while vice president at investment manager Payden & Rygel. "The such as Bloomberg, Tradeweb, FXall, and Creditex. other entities cater primarily to retail traders and investors. price transparency available through e-trading also helps us “Client to multi-dealer electronic trading is now well- MarketAxess is firmly planted in the institutional customer- get a clearer view of the market while helping with our com- established in fixed income and other less-liquid asset to-multi-dealer segment, as most of its revenue is derived pliance requirements, and supporting measurement of best classes,” said McVey. from commissions for trades executed on its platform that are execution." Regulators have proposed conflict of interest rules billed to broker-dealer clients. Fragmentation in the corporate-bond market has under- governing SEFs (swap execution facilities), SDRs (swap “The core of our business is electronic execution,” said pinned MarketAxess' expansion. Primary dealer hold- McVey. “Most trading we do is RFQ or auction-based, where ings, as calculated FEATURE by the Federal Reserve Bank of New business with existing clients, and office (market-data feeds for risk man- kept in the proverbial dresser drawer, such competition, and openness in the swaps credit crisis of 2008-09 provided an extreme York, fell from $218 billion at the end expanding its client base. agers), and back office (pricing, STP as high yield and emerging-market bonds, markets, which are the overriding objec- test of the company’s staying power. of 2007 — just as the credit crisis was “Investors need new sources of liquidity connectivity and compliance-report- agency debt, eurobonds, and credit default tives of the Dodd-Frank Act.” “We have had attractive and consistent gathering force — to $46.6 billion by because of the de-risking and de-lever- ing tools). swaps. Just last year, MarketAxess launched growth, but there have been periods... the end of 2011, requiring investors to aging that’s taking place within the large “Our objective is to provide the lead- an institutional credit-trading system to SEC + CFTC where liquidity became very challenging source liquidity from a broader group dealer community, and investors want to ing global electronic trading platform enhance the functionality of CDS trading. MarketAxess has been regulated by the U.S. in the credit markets as primary dealers of dealers. access that liquidity through electronic for fixed-income securities, connect- MarketAxess’s core trading technology Securities and Exchange Commission since were going through active de-leveraging,” “The reduction in dealer inventory for trading channels,” McVey said. “Institu- ing institutional investors and broker- complies with the proposed rules under its inception, and it will soon be subject to McVey said. “Our strategy was to expand corporate-bond market making is fuel- tions have a clear preference for multi- dealers more easily and efficiently, Dodd-Frank and allows clients maximum regulation by the Commodity Futures Trad- the market-making community and open ing demand for clients to expand their dealer trading platforms because they get while offering a broad array of informa- flexibility in trading CDS indices and single ing Commission as well. “The SEC has always up the credit market to alternative sources trading counterparties in order to have the benefit of competition, transparency tion, trading and technology services,” names. A recent analysis of CDS transac- been a proponent of creating more elec- of liquidity.” more choices for liquidity,” said McVey. and efficiency in one place.” said McVey. tions published by the Federal Reserve Bank tronic trading in fixed-income markets,” McVey drew a parallel between MarketAx- The cornerstones of MarketAxess’ MarketAxess’s bond-trading products While some bond-trading platforms of New York showed that the most active of McVey said. “We are now working closely ess and Markit, a provider of strategy are adding functionality and span the front office (live, executable focus on the more liquid sectors within single-name CDS contracts traded about 20 with both the SEC and the CFTC because of and (via its MarkitSERV subsidiary) post- additional product segments within prices and indicative levels for trading fixed income, MarketAxess works with times a day, and some index CDS contracts their involvement in implementing rules for trade processing for OTC derivatives. fixed-income markets, doing more and market-depth analysis), middle all securities. This includes the stuff traded over 100 times a day. However, the derivatives trading.” “Markit’s businesses are highly comple- majority of single-name CDS contracts trade Regulatory oversight of credit derivatives mentary with MarketAxess,” McVey said. TWO-TIER MARKET LANDSCAPE: SELECT PARTICIPANTS less than once daily, but in large blocks. will be split, with CDS indices falling under “They are primarily in data, trade process- “The CDS market operates very differently the CFTC and single-name CDS falling under ing, and clearing, and we are primarily in than exchange-traded products, which the SEC. trade execution.” Examples Dodd-Frank and MiFID Impact have hundreds of thousands of trades per “This makes it more challenging for us and Since 2000, the companies have taken very §§ Tradeweb §§ Highly diverse group with divergent day,” McVey said. “The CDS market is more others who are active in CDS, because the different growth paths. “They have been §§ Bloomberg product experience and knowledge. similar to the corporate-bond market than same market participants trade both CDS very acquisitive, whereas our growth has §§ MarketAxess §§ Intend to register as SEFs and/ or OTF equities or exchange-traded futures.” indices and single names,” McVey said. “We been primarily organic,” said McVey. “In §§ Thomson Reuters where appropriate as soon as possible. Derivatives exchanges such as ICE, Eurex, will end up with two different sets of rules, total we’ve only done three acquisitions and §§ Javelin §§ Some to experiment with multiple §§ TeraExchange models, including combined RFQ and and CME have launched clearing services and the need to register with both the SEC the two that we have done since 2001 have §§ Eris SwapBook CLOB over time. for credit and interest-rate OTC swaps, and and the CFTC.” not been large.” §§ CrediEx §§ More announced players over time. §§ ICE OTC energy could conceivably offer trading in swaps as The objective of U.S. regulatory reform is In 2007, MarketAxess Technologies §§ List is not exhaustive. §§ TrueSEF well, with exchange-like features such as to promote greater market transparency, acquired Trade West Systems, a provider §§ Others central limit-order books. That’s fine with execution on centralized and regulated of gateway adapters for connecting order- MarketAxess, so long as regulators don’t try marketplaces, and centralized clearing for management systems and trading systems to force CLOBs on the market. standardized swaps. “The overarching prin- to fixed-income trading venues. In 2008, it “We are not opposed to CLOBs,” McVey ciple of the Dodd-Frank Act is that trading acquired Greenline Financial Technologies, said. “We have offered them in the past, should take place on venues that promote a provider of integration, testing and man- and may offer them again in the future. transparency and competition, and the mar- agement solutions for proprietary and FIX However, we don’t believe that an auction- ket should decide what protocols work best Protocol related products and services. MULTIDEALER TO CLIENT (MD2C) USING RFQ AND/OR CLOB based system should be required to offer depending on what swaps they’re trading,” The acquisitions have enabled MarketAx- CLOBs.” said McVey. ess’ electronic trading platform to integrate The applicability of central limit order “The CFTC has been more prescriptive with the work flow of its clients, McVey Examples Dodd-Frank and MiFID Impact books to swaps trading is a hotly debated on proposed rules with some significant said, and also allowed clients to achieve a topic among market participants as the SEC changes versus the way swaps get traded fully automated straight-through process- §§ UBS §§ SEF status uncertain. §§ Credit Suisse §§ Could become SEFs but more focused and CFTC wade through the complexities of today,” he continued. “While the OTC mar- ing (STP) solution from trade initiation §§ Morgan Stanley on SEF facilitation and aggregation. the Dodd-Frank rule-making and imple- ket needs fundamental change, there is a to settlement. §§ Barclay’s mentation process. The CFTC’s proposed risk of negatively impacting market liquid- “STP is making the world of bond trad- §§ Deutsche Bank §§ RBS rules require SEFs to allow market partici- ity or moving swaps trading offshore.” ing more efficient for the middle and back §§ Others pants to leave executable bids or offers that Divergent market-structure standards for offices,” said McVey. “For most of our deal- can be seen by the entire marketplace, i.e., derivatives trading between Europe and the ers and large institutional clients, we are a CLOB. U.S. present opportunities for regulatory fully integrated into their order-manage- “We are perfectly happy to compete with arbitrage. “Clarification is required” regard- ment or trade-capture systems. Once a any entrant, but we think that the deter- ing how the rules will be promulgated on trade is completed on MarketAxess, we send mination on trading protocols that we offer both continents and how cross-border mar- electronic messages through APIs to the should be made by our clients, not by highly ket participants will be affected, said McVey. back offices of both the client and dealer, SINGLE DEALERS (D2C) prescriptive rules,” said McVey. “Auction- As with many young companies, growth and that allows them to process trades more based systems promote transparency, has been nonlinear at MarketAxess, and the efficiently than a phone trade.”

© 2012 Markets Media, LLC. Issued under license to MarketAxess 2/22/2012 marketsmediaonline.com