Repo Invasion

Competition is heating up in the wholesale electronic market for trading repurchase agreements, or repos—short-term contracts that dealers use to finance their positions in the Treasury market. For the past six years, Broker-Tec—owned by ICAP, the No. 1-ranking interdealer broker (IDB)—has been the only electronic trading platform available to securities dealers and banks.

In January, however, TradeBlade—a new electronic brokerage division of No. 2-ranking IDB Tullett Prebon—launched a new electronic trading platform for securities dealers and banks executing U.S. dollar-denominated repos. "We responded to the dealers' request that we create something that was strictly anonymous," says Michael D'Arpino, CEO of TradeBlade, which operates separately from Tullett Prebon's voice brokerage business.

TradeBlade is offering the purely electronic system to Tullett Prebon's existing customers, with a separate back office to ensure that information is kept confidential. Like BrokerTec, TradeBlade's platform is open to wholesale financial institutions that are netting members of the Fixed Income Clearing Corporation (FICC).

Dealers use the e-trading platform to distribute their bids and offers, which are anonymously matched through the system, explains D'Arpino. "The dealers are providing their own liquidity," he notes. "Our voice brokers cannot trade through the screen—in many respects, we are a competitor to our own voice market."

Meanwhile, BGC—a voice broker that was spun off from Cantor Fitzgerald in 2004—expects to go live within the first quarter of this year with a new integrated voice and electronic broking service provided over Cantor Fitzgerald's eSpeed technology platform. In this case, BGC is offering its hybrid platform strictly to the 22 U.S. primary dealers that have a trading relationship with the Federal Reserve Bank of New York. Since eSpeed already has a prominent position on primary dealers' desktops, "If we are going to offer BGC Repo over the same technology, then that makes sense," says Philip Norton, director of e-commerce at BGC in London. Acting as a technology provider, eSpeed will enable BGC to provide repo pricing to the primary dealers via a separate and exclusive liquidity pool.

But will the new entrants be able to penetrate the market dominated by BrokerTec? Launched in 2000 with the backing of 14 leading dealers, BrokerTec was acquired by ICAP in 2003. So far, all three IDBs are focusing on the commoditized part of the repo market, the so-called overnight specials. They are leaving their voice brokers to match trades in so-called term repos, whose maturities typically are one or two months long.

According to one industry source, ICAP has about 50 percent of the overnight repo market and about 70 percent of the overnight specials. However, David Rutter, CEO of ICAP Electronic Broking in the Americas, estimates that ICAP accounts for about 85 percent to 90 percent of the specials market, "or nearly $200 billion a day in volume."

However, the e-trading repo market still remains relatively small, with just 17 percent of interdealer repo trades being conducted electronically, up from 14 percent in 2005, estimates Harrell Smith, manager of the securities and investments practice at financial technology research and consulting firm Celent. But with volume expected to spike over the next few years, industry players are jockeying for position. Celent expects the percentage of interdealer electronic repo trades to increase to approximately 40 percent by the end of 2007. According to figures compiled by the Federal Reserve Bank of New York, cited in a January 2005 Celent report, U.S. primary dealers' average daily outstanding repo positions were $4.8 trillion as of Sept. 30, 2004.

Users of the new IDB platforms already may trade through BrokerTec in the overnight market, but now sell-side firms will have more choices. Joe Blauvelt, who uses BrokerTec as managing director on the U.S. repos desk at JPMorgan Securities, says he is interested in all three platforms. Having more than one repo trading platform is good from a contingency standpoint, Blauvelt says. "What happens the day that BrokerTec doesn't open?" he asks.

But what's spurring this sudden interest in new e-platforms? For one thing, dealers who mainly utilize voice brokers to execute the more-complex term repo transactions are asking the IDBs to automate the more-liquid overnight trades through anonymous platforms. "The interdealer platform for me ... keeps me anonymous," says Blauvelt. "The advantage is the anonymity, the straight-through processing, [and] it's a low-cost provider."

Late to the Party

"Traders don't like to be locked into any single-owned broker trading platforms," observes Celent's Smith. "That works in Tullett's [TradeBlade] favor." He notes, however, that while there is room in the market for new entrants, being late to the party presents its own challenges.

The fact that ICAP is entrenched will work against Tullett's TradeBlade, Smith continues. "On the technology side, the major primary dealers all have dropped APIs [application programming interfaces] in their systems for BrokerTec and certainly for eSpeed as well," explains Smith. In addition, BrokerTec has developed certain advanced back-office functionality that eSpeed will have to create from scratch, he adds.

For instance, with general collateral repos, traders have the ability to substitute another form of collateral—a different security that would conform to their trade agreement. Traditionally, a repo trader has to tell his back office to call the back office of the other side and request the bonds be sent back, which involves amending the trade. According to ICAP's Rutter, BrokerTec has developed technology that automates that function. "We developed functionality ... that allows the dealers to electronically create substitutions and allocate collateral on general collateral deals that they have executed the platform," he says.

Further, Celent's Smith points out that both BrokerTec and eSpeed offer cash trading in U.S. Treasury securities on their respective platforms. This could give them an advantage over TradeBlade, which is starting out with repos and does not currently offer Treasury trading. In response, TradeBlade's D'Arpino notes that Tullett Prebon's screens already have desk space to support existing clients, and the firm has the No. 1 and No. 2 market shares in voice brokering in repos.

>Despite its head start, Smith notes that BrokerTec's platform has not changed much in the last five years. "It's certainly possible that Tullett's [TradeBlade] technology or platform can be that much stronger than BrokerTec's."

ICAP's Rutter, however, disputes this assertion. "We're constantly spending money on improving our technology and we're upgrading certain aspects of our back-end technology," he says.

Hybrid Model Offers Choice

For its part, BGC's hybrid model will offer traders a choice. "Our clients can either post prices and trade themselves through the eSpeed interface on their desktops, or, if they prefer, they can pick up the phone and ask their brokers to input on their behalf the trades into the same liquidity pool," says the firm's Norton. Over the next 12 months, Norton says BGC will examine instant messaging as an alternative to phone lines to enhance the way that clients communicate with brokers.

So with all this competition brewing in electronic repo trading, what does the future hold for ICAP? And is the hybrid offering a prelude to full-blown electronic trading? Until this point, ICAP has kept its voice broker, Garban, separate from BrokerTec, the electronic broking platform. But that seems to be changing. While its rivals are busy concentrating on making inroads into the overnight repos market, ICAP is working on a hybrid service for the term part of the specials market. Meanwhile, ICAP also is upgrading its back-end matching technology and has redesigned its middleware to allow it to present multiple products on the same pipe.

As for competitors offering repos platforms, "There are a couple of potential outcomes here," relates ICAP's Rutter. "When you bring another e-business in, it's going to be very difficult for them to get critical mass," he says. "It does cause the entire Street to sit back and think about the way they do their business. It could cause a broad shift toward electronic trading, which would, of course, benefit us the most," he asserts.

On the other hand, competitors feel they can grab market share, especially if disgruntled customers begin shopping around for alternatives. "People don't look for an option if they're happy with the way things are going," observes one industry insider.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio