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The first interdealer trading platform aimed at opening up credit derivatives markets to new competition has hit roadblocks due to resistance from some banks that dominate such trading, according to several people familiar with the situation.
Derivatives markets continue to revolve around the small group of dominant banks, and credit markets have become more - not less - concentrated since the 2008 global financial crisis.
Regulators have sought to change that by opening up trading to new competition to increase transparency and reduce the concentration of risks seen as one of the factors that contributed to the crisis.
GFI Group, a New York-based broker with an active interdealer credit platform, has been planning to add fund managers for several months. But the brokerage has had to change terms of its trading and multiple funds that planned to participate have pulled out after they came under pressure from some large banks, according to seven people familiar with the situation.
A number of hedge funds and other firms seeking to make markets in derivatives are keen to access new systems. They say that some banks are using their clout to throw up barriers that range from adverse pricing policies, slowing technological innovation and warning them that they may lose access to client markets if they trade on interdealer venues.
Not all fund managers are anxious to join new trading venues and prefer to wait to see how reforms evolve as they also adapt to new technology and regulatory requirements.
Trading mandates are being introduced slowly and there are numerous ways to avoid participation. Banks have also won exemptions that will allow them to maintain much of the current market structure.
"There is a lot of effort to try to maintain the status quo in the market,” said Sean Owens, a director of fixed income research and consulting at Woodbine Associates in Stamford, Connecticut.
Banks argue that they offer several free services, including research, and it is not fair for investors to take advantage of those services and then seek to trade around them. They also argue that many companies and investors are better served with private trades tailored to their specific needs.
None of the large banks active in credit derivatives and contacted by Reuters would speak on the record.
So far, the market is a far cry from the structure envisaged by the regulator, the Commodity Futures Trading Commission (CFTC), which requires all trading venues to be open to any participants and allow all to trade with each other.
Trading swaps on new electronic venues has been one of the most contested reforms of the $300 trillion derivatives markets in the United States as these contracts form a large part of bank profits. A study by consultancy McKinsey in June estimated banks could lose up to $4.5 billion in revenues annually because of electronic trading.
Resistance of established players puts interdealer brokers such as GFI in a bind: they want to open to new clients but cannot afford losing the business of dealers that control the bulk of market liquidity.
“Interdealer brokers have always wanted to get customer business," said David Weiss, senior analyst at research firm and consultancy Aite Group in New York. "But the banks will say, 'if you do that I'll pull my business and I'll tell everyone else that I'm pulling my business and I'll tell them why'.”
Some banks are more open to market reforms than others and Weiss expects ingrained habits and technical issues that also slow the change to be overcome over time.
“At some point it's going to happen, the time it takes for this transition to occur is decreasing,” Weiss said.
BANK PRESSURE
GFI dropped plans for fully anonymous trading on its credit platform because of pressure from several banks, said four people familiar with the situation. GFI spokesperson Patricia Gutierrez declined comment.
Revealing trading parties after a trade gives banks certainty that they are only trading with other dealers, who typically receive better prices. But it identifies fund managers if they gain access, exposing them to backlash from large banks.
The Managed Funds Association, which represents the world’s largest hedge funds, said in a letter to the regulator last month that revealing names risks “potential retaliation by liquidity providers in the still prevalent dealer-to-customer market.”
Several hedge fund managers that had planned to join GFI’s credit platform received phone calls from multiple banks that indicated that they would stop trading with them or send them unfavorable pricing if they joined an interdealer venue, people familiar with GFI plans said.
At least three funds backed away after the calls, which were made in May when GFI was getting ready to add fund managers to its credit platform.
People contacted by Reuters declined to speak on the record or name the funds or banks involved, citing retaliation concerns.
Today, asset managers depend on a few large banks to access the market. Order books, such as interdealer venues are not yet anonymous or open and liquid enough and banks' refusal to trade with funds would severely crimp their trading abilities.
Unlike the $580 trillion interest-rate swaps market, the largest and most diverse privately traded derivatives market, the $21 trillion credit derivatives market is highly concentrated, and dominant banks can better control access.
Not all fund managers are seeking changes. Many investors want to count among a bank’s favored clients, which can carry privileges such as being among the first to be offered new issues and more favorable swaps pricing.
Funds that are eager to start trading on order books, though, cite a number of barriers to access and the hedge fund association has asked the regulator to prioritize a review of the trading venues to address these.
It also asked the regulator to finalize rules that would restrict bank ownership of swap execution facilities because of conflicts of interest.
Banks' pressure stalls opening of U.S. derivatives trading platform | Reuters
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