View Count: 74 |  Publish Date: April 04, 2013
Bond Traders Club Loses Cachet in Most Important Market
By Christine Harper & Daniel Kruger - 2013-04-04T04:01:00Z
Primary dealers, the select group ofbanks and brokers that have held a seat at the center of theU.S. government debt market since 1960, are losing influence.
More than 20 percent of the $538 billion of Treasury notesauctioned this year have been awarded to bidders who bypassedthe dealers by using a website to place their orders, accordingto data provided by the U.S. Treasury Department. That’s almostdouble the 2011 level and up from 5.6 percent in 2009.
In the same way technology eroded the middleman role onceplayed by travel agents and stock-market specialists, increaseduse of the direct-bidding system threatens government-bondtraders at firms ranging from Bank of America Corp. to UBS AG. (UBSN)It also has eaten into profits from a business that’s among theleast affected by the regulatory changes and new capitalrequirements reshaping the industry.
“You’ll see clients do a lot more things in a self-sufficient manner than they used to do before,” said Richard Prager, global head of trading at BlackRock Inc. (BLK), the world’slargest asset manager with $3.8 trillion. “It’s just therealities of today.”
Traders at primary dealers have complained to the Treasuryand the Federal Reserve Bank of New York about direct bidding,which they say is reducing their profitability, according toseven government-bond traders who requested anonymity becausethey weren’t authorized to comment publicly. Their job isbecoming more frustrating, and sometimes money-losing, now thatthey’re competing in auctions against anonymous investors whocan show up at any time and at any price, the traders said. Investor Shelter
“A lot of the value of being a dealer is being at thenexus of the information flow,” said Jason Evans, a formerTreasuries trader at Goldman Sachs Group Inc. (GS) and Deutsche BankAG (DBK) who started his own fund, Ninealpha Capital LP, in 2009.“That is being eroded through electronic trading and directaccess to exchanges, and it’s also being eroded in the primarymarket through Treasury direct access. It’s just an erosion oftheir competitive advantage.”
As the deepest and most-liquid bond market in the world,U.S. Treasuries have served for decades as a shelter forinvestors fleeing risks such as the 1987 stock-market crash, theRussian government’s 1998 debt default, the Sept. 11, 2001,terrorism attacks and the 2008 financial crisis. The defaultinvestment of governments such as China and Japan, Treasuriesserve as a benchmark for everything from corporate borrowingcosts to home loans. Primary Dealers
Primary dealers are required to bid for no less than theirpro-rata share at Treasury auctions -- 4.76 percent for each ofthe 21 dealers currently designated by the New York Fed. Bidsmust be “reasonable” compared with the range of prices in theso-called when-issued market before an auction, according to NewYork Fed rules. The dealers also provide market commentary andanalysis helpful in conducting monetary policy and act ascounterparties when the Fed buys or sells bonds.
Direct bidding was introduced more than a decade ago bythen-Undersecretary of the Treasury Peter R. Fisher, accordingto Timothy S. Bitsberger, assistant secretary for financialmarkets at the time. Fisher thought the auctions should be freeand open and that forcing institutions to route orders throughprimary dealers undermined that goal, Bitsberger said. Fisher,now at New York-based BlackRock, declined to comment.
“The system works well for the dealers if all the biddingis channeled through them,” said Bitsberger, now head ofofficial institutions coverage at Paris-based BNP Paribas SA (BNP), aprimary dealer. “On the other hand, the investors feel, why dothey have to give up this information?” Anonymous Bidders
The Treasury doesn’t reveal the identities of directbidders. A February analysis by New York Fed Vice PresidentMichael J. Fleming found that other dealers and brokers,investment funds and foreign investors have increased theirparticipation in auctions. The share awarded to depositoryinstitutions, pension funds and individuals hasn’t changed.
One strategy for primary dealers is to sell Treasury debtto clients in advance with the intention of buying at a lowerprice at auction, said the traders. The strategy has failed insome cases when direct bids came at a higher price than dealershoped to pay, saddling them with a loss, they said. That’sleading traders to become less aggressive in bidding and couldresult in higher yields at future auctions, some warned. Dealer Appetite
Dealers have won 22 percent of the securities they have bidfor this year through the end of March, compared with 26 percentin 2009, according to data compiled by Bloomberg. Their share ofthe auctions has shrunk to 46.4 percent from 49 percent in 2009.
The Treasury hasn’t seen any indication that the increasein direct bidding has reduced primary dealers’ appetite atauctions, according to a senior official in the department. Theofficial said firms are still applying for the designation.
Even with record debt, higher demand for U.S. Treasurieshas helped suppress borrowing costs as a percentage of thecountry’s gross domestic product.
“Our basic view continues to be that having broad accessto the auction process generates competition,” Matthew Rutherford, assistant Treasury secretary for financial markets,said in an interview.
Pacific Investment Management Co., the world’s largestactive bond manager with $2 trillion, likes direct biddingbecause of the anonymity it offers and because it has reducedthe price swings that used to occur before auctions as dealersreacted to the bids they received, said Steve Rodosky, who runsTreasury and derivatives trading at the Newport Beach,California-based firm. BlackRock Philosophy
“One of the weaknesses in the old-fashioned model was thefact that with five or 10 minutes to go you share informationabout size and price with somebody else in the market,” Rodoskysaid. “And from time to time that information would be used tosomebody else’s advantage because they would know that peoplewere eager to buy or that nobody was eager to buy.”
Pimco still places most of its auction orders throughdealers because they’re better set up than the direct-biddingsystem to handle bids for funds with multiple accounts andcustodians, Rodosky said. If that technical issue could beresolved, Pimco would use the system more, he said.
BlackRock, by contrast, doesn’t bid directly because itwants to reward primary dealers for their research and othertrading help, according to Prager.
“While we can go direct, most of the time we don’t,”Prager said. “We feel that the dealers provide us with a lot ofservices. Our philosophy at this point is, to the extent we canshare some of that information with trusted partners who won’tmisuse that information, we prefer to reward the primary dealersthat provide us all that value.” More Borrowing
The latest version of the direct-bidding system, introducedin 2008, is used by 266 investors, according to data provided bythe Treasury. Ninealpha’sEvans said he doesn’t bid directly, inpart because “we have a limited number of primary dealers thatwe interact with and we value the relationships.” Still, mostdealers know their biggest clients use the system, he said.
“The primary-dealer community has a pretty good idea thatall of the big accounts probably have the lines set up so thatthey can bid directly,” Evans said.
The Treasury’s borrowing needs have soared since thefinancial crisis, climbing to a peak of $2.25 trillion in 2010from $581 billion in 2007. In 2009, the Treasury adopted aschedule of monthly sales of notes with maturities of two,three, five, seven, 10 and 30 years, as well as one auction amonth of inflation-protected securities in maturities from fiveto 30 years. The government also sells short-term bills weekly. Trading Volume
The record debt sales, combined with the Federal Reserve’squantitative easing policy of buying Treasury bonds, haveboosted interest in the market. There are five more primarydealers today than at the end of June 2009, as U.S. units ofRoyal Bank of Canada (RY), Nomura Holdings Inc. (8604), Societe Generale SA (GLE),Bank of Montreal (BMO) and Bank of Nova Scotia (BNS) won the New York Fed’sapproval. The 21 dealers today compare with 18 when the programstarted and with a peak of 46 reached in 1988.
The increase in outstanding debt hasn’t translated to thejump in trading some dealers anticipated. An average of $548billion of Treasuries has traded weekly this year, according toprimary-dealer transaction data compiled by the New York Fed.That compares with an average $546 billion weekly in 2006 and2007, before government borrowing ballooned. Electronic Platforms
There are multiple explanations for why direct bidding hassoared. Pimco’s Rodosky attributes it to investors’ greatercomfort with electronic trading. Firms including BlackRock andprimary dealers Citigroup Inc. (C) and Goldman Sachs have startedelectronic bond-trading platforms in the last year. BloombergLP, the owner of Bloomberg News, also operates a platform.
Darrell Duffie, a finance professor at Stanford Universitynear Palo Alto, California, said investors have been driven toplace direct bids by increased competition for the notes andbonds. The Fed’s purchases, new collateral rules that requiremore trades to be backed up with Treasuries and a desire forsafety from risks in Europe have all whetted appetite in themarket, Duffie said.
Ninealpha’s Evans said the rise in direct bidding may havemore to do with the size of some Treasury investors, includingforeign central banks, money managers and hedge funds. Anychange in strategy can have a big effect on the market, he said. China, OPEC
The Fed is the biggest holder of U.S. Treasury debt, withmore than $1.79 trillion, according to central bank data throughMarch 27. China holds $1.26 trillion, Japan $1.12 trillion andthe Organization of Petroleum Exporting Countries $262 billion,Treasury data through January show. Among U.S. investors,Vanguard Group Inc. has $155.6 billion, Pimco $148.6 billion andBlackRock $62.9 billion, data compiled by Bloomberg show.
For large investors, “to make a meaningful change in theirinvestment portfolio or to reinvest requires the movement oflarge positions,” Evans said. “There’s some concern abouttipping their hand to the broader marketplace.”
Banks around the world have been cutting jobs and sellingunits as they struggle to adapt to new requirements imposedafter the 2008 financial crisis. The $11.3 trillion U.S.government bond market offers some sanctuary. Regulators assignzero credit risk to Treasuries, and trading in the bonds isexempt from the so-called Volcker rule, which prohibits banksfrom making proprietary trades on their own behalf. Financial Ecosystem
The desks that trade Treasuries still need capital to guardagainst potential losses from market movements or operationalmistakes. That adds to a bank’s risk-weighted assets, or RWA,increasing the capital required, BlackRock’s Prager said.
“Even something that sounds benign like a Treasury market-making operation actually has much more RWA than is obvious atfirst glance,” Prager said. “We’re all in this big financial-services ecosystem, and everyone’s choosing what activities theywant to be excellent in and what activities they want to exit.”
Credit Suisse Group AG (CSGN), the second-biggest Swiss lender,eliminated about eight jobs on its U.S. government-bond tradingdesk last month, including the former head of the group, Jim O’Brien, according to a person with knowledge of the matter.While some traders at competing primary dealers said the cutsreflected pressures on Swiss-regulated firms, others said it wasa sign of the reduced return on capital from the Treasury desk.
Banks and broker-dealers don’t report how much profit theymake from trading Treasuries, let alone from auctions, insteadlumping those gains into a category called rates thatencompasses all government bonds and related derivatives. Tight Ranges
“The markets are, because of the tight ranges, veryquiet,” said John Fath, a former head Treasury trader atZurich-based UBS who’s now a principal at investment firm BTGPactual in New York, which manages $2.5 billion. “Then to addinsult to injury you have direct bidding going on in theTreasury, where that’s at least one part of the market whereyou’re able to make a little money, and now that’s not evengiving you an edge.”
The yield on 10-year Treasury notes has remained between1.58 percent and 2.06 percent over the past six months, a narrowrange for traders trying to book profits on price swings. That’salso made it difficult for banks trying to justify the cost ofemploying 30 traders in a primary dealership, Fath said.
“The primary dealers are kind of in a bind here in thesense that they’re being required to buy securities from theFed, but they’re doing so with a lot less information thanthey’ve had in the past,” said Bitsberger of BNP Paribas.“Maybe the Fed needs to look at primary dealers differently andnot necessarily require them to bid in all auctions.”
Jonathan Freed, a spokesman for the New York Fed, declinedto comment.
BlackRock’s Prager said trading Treasuries eventually willbecome a more electronic market and that the role of primarydealers will change.
“Primary dealers play a critical role, but it’s muchreduced,” said David Jones, 74, who rose to vice chairmanduring 30 years at Aubrey G. Lanston & Co., one of the originalprimary dealers before it closed in 2002. “The world haschanged. The technology itself has changed so much.”
To contact the reporters on this story:Christine Harper in New York at;Daniel Kruger in New York at
To contact the editors responsible for this story:David Scheer at;Dave Liedtka at

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