This shouldn’t come as a surprise to anyone: Another financial player is attempting to bypass big Wall Street institutions by setting up a rival platform to perform one of the key functions of firms like Goldman Sachs. The only novel twist to the new platform, being called the Aladdin Trading Network, is that the initiative is coming from BlackRock Inc., a firm that has traditionally been on the “buy side” of Wall Street, rather than from one of the host of smaller would-be competitors to try offer slightly new versions of the traditional industry model.
Even that shouldn’t be tremendously startling. At the height of the financial crisis, a private equity manager to whom I spoke suggested that this kind of effort to disintermediate some of Wall Street’s traditional functions would inevitably occur, sooner or later. After all, he explained to me then, why shouldn’t a buyout firm like his own – which invested in scores, if not hundreds of portfolio companies at any given time, and was intimately familiar with their balance sheets – be in the best position to effectively “underwrite” issues of bonds and perhaps even of stocks?
After all, underwriters today do their work for a cash payout representing a percentage of the sums they are raising for their client, and typically then simply walk away. In his firm’s case, they could point out that they had “skin in the game.”
True, that scenario is far from being perfect (and perhaps that’s one reason why to date no serious attempt seems to have come from the buy side to replicate Wall Street’s functionality in a bid to displace the “too big to fail” firms), but the financial crisis created an impetus to reshape Wall Street that may have gone underground but hasn’t vanished.
Had the issue only been one of fees – BlackRock honcho Larry Fink is on record as griping over the occasionally very wide spreads between the prices at which Wall Street traders are willing to buy a bond and those at which they are trying to sell – BlackRock might have stuck with grumbling publicly. Those spreads, of course, make up the profits for the Wall Street market-makers, and generate bonuses for the traders and their bosses, but they are paid by the “buy side,” –asset management firms who emerged from the crisis in a far stronger position than their sell-side counterparties.
Far more important than wide spreads, though, is the lack of liquidity in the fixed-income market that investors of all kinds have been complaining about for well over a year. Wall Street firms, under pressure to cut costs and seeing some of their most skilled traders pack up and leave for jobs where their bonus payments will reflect their ability to generate hefty sums for their firms rather than what is politically palatable, are less willing or able to “make markets” than they were in the pre-crash days. That means that sometimes a BlackRock portfolio manager who decides to sell a block of bonds can’t quickly find someone to take the other side of a trade, or must pay an even larger premium in the form of a higher spread to execute his transaction.
Ask a buy-side manager what they think of dealer-provided liquidity, and brace yourself for a tirade. The growing fury with the lack of liquidity being provided by major institutions has led smaller or newer players – like PrinceRidge, the focus of an earlier Risk/Return column – to beef up their operations in some of these market-making businesses in order to meet the need for this service. So it was only a matter of time before a customer like BlackRock decided to bring the whole shebang in-house.
As reported in yesterday’s Wall Street Journal, BlackRock plans to offer some four dozen giant buy-side clients (sovereign wealth funds, insurance companies) access to an electronic trading platform that will match their buy and sell orders at a much lower fee. (It began such “crossing” in house, encouraging managers of its stock, bond and other funds to trade with each other, several years ago.)
Presumably, BlackRock hopes that the portfolios of these entities are so large that liquidity won’t be a major issue: Many investment banks have pointed out that the value proposition of their market-making operations doesn’t lie just in their ability to execute a transaction but literally in their ability to make a market – to be the middleman willing to buy and warehouse securities in the hours, days or even weeks it might take to find a buyer and to take the price risk associated with that. BlackRock’s system, which simply would match what someone wants to sell with what someone else wants to buy, wouldn’t offer that extra feature.
It’s unclear how much volume BlackRock’s Aladdin – or any other single initiative that might be in the works – can really steal from Wall Street. But the BlackRock move coming at such a critical juncture in the debate over what lies ahead for investment banks on Wall Street from both a business and regulatory perspective is particularly striking.
It could be a flash in the pan – or it could be the beginning of something that will transform the dealer-driven bond market in the same way that electronic communication networks (ECNs) shook up the world of stock trading beginning in the 1990s. Of course, in the latter case, the big Wall Street firms rapidly took steps to try to retrieve some of the ground they lost by acquiring those ECNs, or overseeing mergers between them. Certainly, it’s unlikely that rival marketmaking trading platforms in the bond market, to the extent that they are promoted by smaller investment banks or stand-alone platforms, will remain independent for long – the incentive for a Goldman Sachs or a JPMorgan Chase to acquire them to bolster their own trading desks will simply be too great.
But BlackRock’s initiative is a different kind of challenge to the status quo, coming from a firm that in its own way is just as powerful as those investment banks – and certainly has a stronger reputation with the public and with Washington. His initiative may well still fail, but Larry Fink has flung down the gauntlet to Wall Street, telling it that it has to do a better job serving its clients or face losing them.