Very few people would disagree that the US Treasury market is broken.
Direct Match was borne out of my ideas of how to make it work better for everyone.
The Treasury market is different from other financial markets in that it combines a high level of opacity with a light regulatory environment. It also has been undergoing a profound evolution since the financial crisis. Reforms passed in response to the crisis have reduced dealer balance sheets committed to market making. Meanwhile, high-frequency trading firms have leveraged technology to dominate the interdealer platforms from which dealers source liquidity.
Institutional investors, whose liquidity demands continue to grow, have little access to the interdealer market and have few options but to execute via phone with large primary dealers. These and other factors have accelerated the evolution and fragmentation of the market.
I saw these trends accelerate as a software developer and algo trader at GETCO (now KCG) and Jefferies and was mindful of the dangers it presented to the market as a whole. My customers, especially the largest hedge funds and asset managers, had a more difficult time accessing liquidity.
The current system did not feel very sustainable, and so despite a new mortgage, I left my comfortable trading job in the Fall of 2014 to build a solution that would attack the structural issues of the market. That solution became Direct Match, which I founded with the mission of creating the first all-to- all trading venue for US Treasuries.
The first few months with no paid staff were not the most glamorous of my career, but positive feedback from customers encouraged me to keep going and convinced me that I was on the right track. In just under two years my team pitched over 200 customers and received commitments from 60. That level of enthusiasm allowed us to raise close to $9 million, which in turn allowed us to build a FINRA-registered broker-dealer and recruit a passionate team of 16 associates.
Most of my team have long sell-side careers, and they were just as excited as I was about shaking up the boring
world of Government bonds.
Everything was going smoothly (in retrospect, too smoothly) until a few weeks before we were set to officially launch in March 2016. My team pulled off heroic last minute efforts to finish paperwork and to integrate software with more than twenty customers. Then, the week we were to do the first live trades, our strategic clearing partner pulled out. Their CEO cited “conflicts of interest.”
This was a decisive blow. Without a clearing solution, we could not launch.
My team scrambled to replace the strategic partnership that they had spent the prior six months building. We were confident we could find a new partner because the front-office solution was so compelling to our customers. However, this proved much more difficult than we thought.
At first, the reason for our difficulties was not clear given how common new entrants are in other asset classes. Slowly it became clear that there are deep problems in US Treasury clearing as well. In US Equities, for example, the clearing solution (the NSCC) is a utility to which any broker-dealer has access. Uniquely in Treasuries, the dealers are serviced by a utility (the FICC) that they own, and everyone else is at the mercy of an ever shrinking oligopoly of clearing firms who are themselves dealers, or are dependent on them.
Thus far, we have not been able to put together a clearing solution that would satisfy the all-to- all mission that I originally set out to achieve.
My greatest error was that I was so committed to altering the competitive landscape in the front-office that I did not adequately structure the firm to simultaneously attack the uncompetitive landscape in the back-office.
With the current firm and capital structure, we will not be able to execute on our vision anytime soon.
As a prudent measure, the team has started to explore other strategic options that would either fortify the firm’s capital or align it more closely with strategic partners that would enable us to realise our vision.
Despite the setbacks we have suffered and the uncertain future of the firm, I am more convinced than ever that the secondary market will look more like Direct Match in the future. Dodd-Frank, the Volcker Rule, and Basel III are here to stay.
Dealer liquidity will continue to deteriorate while buy-side demand increases unabated. Matt Levine will continue to write a daily section on why “People are worried about bond market liquidity.” However, until market participants pay more attention to the plumbing of the Treasury market, little may actually change.
We recently suggested in our response to the US Treasury’s request-for-information about the “Evolution of the US Treasury Market” that regulators should take the initiative by establishing a uniform clearing regime across the market structure.
A clearing regime with fair access rules and a reasonable pricing schedule would enable greater competition for order flow and a proliferation of venues that compete on features and price. Savings from greater competition in the secondary market ultimately would be passed back to taxpayers through a lower cost of financing the national debt.
I think that these issues will work themselves out in the next few years, whether through marketplace solutions, changes to the regulatory regime, or a combination of both.
Direct Match may have just been ahead of its time.
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