This is a comprehensive article on the state of the primary dealer business from Bloomberg. I spent the preponderance of my career working as a salesman or a trader at primary dealers or for firms aspiring to be primary dealers. The value of that franchise has eroded over the years and I would assign the blame to technology. When I began my career the dealer held all of the power. That relationship has shifted and now the client is in the driver seat and holds an advantage over the dealer. I would offer two quick points. When I began in the business in the late 1970s the dealer and its salesmen were the focal point for information. Clients needed to have a strong relationship with the primary dealer community because there was very little transparency in pricing and customers literally needed dealers to learn where off the runs traded.\u00a0 Second quick point. The advent of electronic trading has destroyed relationships. What do I mean? In that bygone era a client would generally call one dealer and get a price. A good salesman would keep the client on the phone and try to find out the price at which the client would deal. A good salesman would cajole and coax a client for a risk free order at a stated price so that his firm would not need to take risk. Now the advent of electronic trading has mitigated the client’s need for a strong relationship with a dealer. Everyone can see a price on Bloomberg or TradeWeb. And that has encouraged clients to execute virtually every trade in competition. So clients will now leave the salesman out of the transaction process and will submit the trade on one of the electronic platforms and execute on the best price received from four or five dealers.\u00a0 They will do this on trades as small as $10,000. In addition bid offer spreads have collapsed and the electronic trading platforms encourage trading in the middle of the market. So it is not the best of times to be a primary dealer.<\/p>\n
I was speaking the other day with a former colleague who is still in the business and he was lamenting the difficulty in selling bonds in the current environment. He posited that dealer firms will eventually cut back significantly on the number of salesman via a change in the coverage model. Now a dealer firm will have one salesman selling liquid interest rate products and another hawking\u00a0 credit product and someone else marketing FX. My friend thinks that eventually one salesman will cover all of those product sectors.<\/p>\n
Via Bloomberg:
\nBond Dealers Seek U.S. Treasury\u2019s Help in Regaining Grip on Debt
\n2014-02-24 00:00:23.0 GMT<\/p>\n
By Daniel Kruger, Kasia Klimasinska and Caroline Salas Gage
\nFeb. 24 (Bloomberg) — The Masters of the Universe
\nimmortalized by Tom Wolfe in his 1987 novel \u201cThe Bonfire of the
\nVanities\u201d are feeling like mere mortals.
\nThe Wall Street banks known as primary dealers because they
\nget to trade with the Federal Reserve and raise the money that
\nthe U.S. government needs to operate are concerned that they are
\nbeing marginalized because of advances in technology. So worried
\nare they that the group wants the Treasury Department to curb
\nthe increasingly popular practice by investors of buying bonds
\ndirectly from the government without their involvement.
\nIn many ways, the request underscores the changing nature
\nof the business, where greater access to information has leveled
\nthe playing field between banks and investors, and turned
\ntelephones into little more than paperweights. A record 49
\npercent of Treasury trading was done electronically in 2013 and
\nthe amount of debt sold directly to investors at auction rose to
\n17.7 percent of issuance from 2.5 percent in 2008. The number of
\nprimary dealers has shrunk to 22 from the peak of 46 in 1988.
\n\u201cThe Treasury needed the dealer community for its
\ninformation, for its distribution,\u201d said E. Craig Coats Jr.,
\nwho was the co-head of the government bond trading desk at
\nSalomon Brothers in the 1980s, when the partnership was Wall
\nStreet\u2019s biggest bond trading firm. \u201cToday there\u2019s so many
\ndifferent sources of liquidity and information and distribution
\nthat the dealers become less important to the Treasury.\u201d<\/p>\n
\u2018Breaking Down\u2019<\/p>\n
Primary dealers, which include JPMorgan Chase & Co.,
\nGoldman Sachs Group Inc., Bank of America Corp. and Citigroup
\nInc., are seeing their roles diminished just as the Fed begins
\nto unwind the extraordinary monetary stimulus measures put in
\nplace after the 2008 financial crisis. That includes bond
\npurchases that swelled the assets on the central bank\u2019s balance
\nsheet to a record $4.15 trillion from less than $1 trillion.
\nAt the same time, government borrowing has more than
\ndoubled the amount of tradable U.S. government debt to $11.8
\ntrillion. That combination has dealers concerned that there\u2019s an
\nincreased chance of disorder in markets if demand for Treasuries
\ndeclines. Forecasters predict higher yields, which would reduce
\nthe value of existing bonds.
\n\u201cThis is an oligopoly that\u2019s breaking down and the
\noligopolists are concerned,\u201d said Robert Eisenbeis, a former
\ndirector of research at the Federal Reserve Bank of Atlanta and
\nvice chairman and chief monetary economist for money-management
\nfirm Cumberland Advisors in Sarasota, Florida.<\/p>\n
Influential Membership<\/p>\n
The request by the dealers was revealed on page 58 of a 74-
\npage chart presentation accompanying the report that the
\nTreasury Borrowing Advisory Committee, or TBAC, presented to the
\ngovernment this month and made public. The 15-member group is
\nmade up of the world\u2019s most powerful and influential banks and
\ninvestment firms.
\nThe committee, which makes recommendations to the Treasury
\non its borrowings and briefs it on market conditions, suggested
\nsetting curbs on investors\u2019 ability to circumvent the dealers
\nand buy bonds directly from the government because the
\nunpredictable nature of that demand \u201ccould potentially lead to
\nincreased debt funding costs\u201d for the government.
\nThey also suggested the U.S. consider the potential for
\nsyndicated sales of securities such as ultra-long maturity bonds
\ndue in more than 30 years and granting underwriters the option
\nto buy additional debt at the Treasury offerings. Those measures
\nwould tighten their grip on the sales process.<\/p>\n
Taking Stock<\/p>\n
TBAC Chairwoman Dana Emery, the chief executive officer of
\nmutual-fund firm Dodge & Cox Inc. in San Francisco, declined to
\ncomment, said her spokesman, Steve Gorski. All of the 14 other
\nmembers either declined to comment or didn\u2019t return calls.
\n\u201cWe\u2019re always trying to take stock of where we\u2019re at and
\nmake sure we understand how new developments in the marketplace
\nare impacting our ability to finance ourselves,\u201d Matthew
\nRutherford, the Treasury\u2019s assistant secretary for financial
\nmarkets, said in a Feb. 20 telephone interview.
\nEnsuring that the government is getting the best rates
\npossible on its borrowings is no small matter with the Treasury
\nselling more than $2 trillion of notes and bonds a year. That\u2019s
\nup from an average of $659 billion in the five years before the
\n2008 financial crisis.
\nUnlike dealers, direct bidders aren\u2019t required to bid at
\nevery Treasury auction. That means their decision to participate
\nmakes government debt sales less predictable, the TBAC has said
\nin its reports. As a result, dealers may need to reduce their
\nbids to compensate for the added risk.<\/p>\n
Rising Share<\/p>\n
Direct bidders submitted $829.2 billion in bids last year,
\nand were awarded $351.1 billion, or 17.7 percent of the $1.99
\ntrillion in competitively sold U.S. debt, according to Treasury
\ndata compiled by Bloomberg. All were record amounts.
\nIn 2008, direct bidders tendered $25.4 billion and were
\nawarded $20.2 billion, or 2.5 percent, while dealers submitted
\n$1.47 trillion of bids for $809 billion of competitively sold
\nsecurities, winning $554.7 billion, or 68.6 percent.
\nThe increased availability of data and the advancements in
\ntrading technology have leveled the playing field, giving
\ninvestors access once enjoyed only by the dealers.
\n\u201cI can enjoy a primary dealer level of access to both the
\nprimary and secondary markets,\u201d Jason Evans, co-founder of
\nhedge fund NineAlpha Capital LP in New York and the former head
\nof U.S. government bond trading at Deutsche Bank AG, said in a
\ntelephone interview.<\/p>\n
Trading Decline<\/p>\n
Trading in fixed-income, currencies and commodities at the
\n10 largest global investment banks declined 19.4 percent in 2013
\nto $73.9 billion, according to research firm Coalition Ltd. The
\n\u201canticipation of rising interest rates, tougher capital
\nadequacy regulations and concerns over the U.S. Fed \u2018tapering\u2019
\nweighed on the business,\u201d Coalition said in report last week.
\nIncreased regulations after the financial crisis to limit
\nbanks\u2019 risk-taking \u201cis increasingly stifling for the dealers,\u201d
\nEvans said last week. \u201cPrimary dealers have seen the true value
\nproposition in being a primary dealer eroded over time.\u201d
\nEven though the amount of debt has expanded, trading
\nactivity is stagnant, with $544 billion of Treasuries on average
\nchanging hands each day in 2013, down from $553 billion in 2008,
\nFed data show. Electronic trading has increased from 31 percent
\nin 2012, according to a survey of institutional money managers
\nby Greenwich Associates.
\nCoats, who worked at Salomon when its influence was
\ncaricatured in \u201cBonfire of the Vanities,\u201d said he trades
\nTreasuries via exchange-traded funds. The 66-year-old retired in
\n2009 as co-head of fixed income at Keefe, Bruyette & Woods Inc.<\/p>\n
Bond Losses<\/p>\n
Treasuries in 2013 suffered their first losing year since
\n2009, dropping 3.35 percent in value as yields rose, according
\nto Bank of America Merrill Lynch index data.
\nYields on 10-year notes are forecast to climb again this
\nyear, to 3.37 percent, according to the weighted average in a
\nBloomberg survey of 74 participants. Last week, the yield on the
\nbenchmark 2.75 percent note due in February 2024 was little
\nchanged at 2.73 percent, Bloomberg Bond Trader prices show.
\nBanks began to exit the dealership business in the 1990s as
\nthe large number of firms and the increased transparency of
\nelectronic trading cut the spread between offers to buy and sell
\ndebt, making activity less profitable.
\n\u201cIt\u2019s a tricky balancing act about keeping costs as low as
\nyou can but at the same time not disenfranchising dealers,\u201d
\nsaid John Fath, a former head Treasury trader at Zurich-based
\nprimary dealer UBS AG. He\u2019s now a principal at investment firm
\nBTG Pactual in New York, which manages $2.5 billion.<\/p>\n
\u2018Meaningful Intermediary\u2019<\/p>\n
Treasury officials understand the difficulty posed for
\ndealers by the erosion of their dominance at the auctions and as
\nnew regulations limit their ability to commit capital to their
\nbond businesses, according to Karthik Ramanathan, a former
\nTreasury debt management director
\nDealers still \u201coffer a meaningful intermediary\u201d between
\nthe market and the Treasury, Ramanathan, who is now a senior
\nvice president at Fidelity Investments, said in a telephone
\ninterview from Merrimack, New Hampshire. \u201cI do not believe at
\nthis point direct bidding or technology is going to completely
\ndisintermediate the primary dealer structure.\u201d
\nA primary dealership still carries some allure. Toronto-
\nDominion Bank\u2019s TD Securities was named one by the Fed on Feb.
\n12, the first new dealer in more than two years. Stamford,
\nConnecticut-based Pierpont Securities LLC is interested in
\nbecoming one, according to Mark Werner, its chief executive
\nofficer.<\/p>\n
\u2018Certain Distinction\u2019<\/p>\n
\u201cTypically, central banks and sovereign funds, the biggest
\nholders of U.S. Treasuries, will only deal with primary
\ndealers,\u201d Werner said in a telephone interview. \u201cThere\u2019s a
\ncertain distinction that comes with being a primary dealer.\u201d
\nWerner, who worked at JPMorgan Chase for 22 years, where he
\nrose to vice chairman before co-founding Pierpont in 2009, and
\nin 2010 was a member of the TBAC, acknowledges the challenges.
\n\u201cYou\u2019re in a low rate environment, with relatively low
\nvolatility and low turnover in the asset class,\u201d he said. \u201cThe
\nresult is a somewhat less profitable environment for dealers.\u201d
\nThe Treasury may face \u201cperception issues\u201d if it adopts
\nthe TBAC\u2019s recommendations, said Dean Baker, co-director of the
\nCenter for Economic and Policy Research, a Washington-based
\ngroup funded by labor unions and private foundations.
\n\u201cThe idea that somehow the Treasury would get a higher
\nprice for its bonds with fewer people bidding, that\u2019s not the
\neconomics I learned in school,\u201d Baker said in a telephone
\ninterview.
\nThe Treasury\u2019s bailout of the banks during the financial
\ncrisis created the notion that the biggest lenders were too big
\nto fail and created \u201cimplicit subsidies\u201d for them, according
\nto Cumberland\u2019s Eisenbeis.
\n\u201cIt\u2019s no wonder they\u2019re going to say they\u2019re concerned
\nabout their profitability,\u201d he said. \u201cThat\u2019s pure self-
\ninterest and has nothing to do with the efficacy or the
\nfunctioning of that market.\u201d<\/p>\n","protected":false},"excerpt":{"rendered":"
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