Aladdin’s new lamp

April 13, 2012

One of the big players in the fixed income market, BlackRock, is out with news that it will be providing a “crossing platform” to allow the world’s largest institutional players to trade bonds with each other:

BlackRock Inc. is planning to launch a trading platform this year that would let the world’s largest money manager and its peers bypass Wall Street and trade bonds directly with one another…

The trading platform would be run by the New York-based company’s BlackRock Solutions arm and offer 46 clients – including sovereign-wealth funds, insurance companies and other money managers – the ability to trade in corporate bonds, mortgage securities and other assets, company executives say.

Only BlackRock can pose a substantial challenge to Goldman Sachs, Morgan Stanley, JPMorgan and other incumbent investment banks on the bond-trading front. With the launch of an eBay-like place for the world’s largest fixed income traders, BlackRock CEO Larry Fink is challenging the investment banks’ dominance in fixed income trading. Wall Street commands fixed income markets not only because its leveraged balance sheets give it the ability to provide immediate liquidity for trades but, more important, because it underwrites 99 percent of all new bonds. Wall Street knows who owns which bonds and at what price. This has given the investment banks enormous influence over insurance firms, pension funds and commercial banks in suggesting when to sell old bonds and in setting price levels for new bonds. Fixed income trading desks in megabanks have mapped the universe of fixed income ownership in a way that is unmatched by other firms.

Except maybe for BlackRock. The firm’s power is its Solutions group, the army of geeks who have designed and built the best-in-class portfolio management, analytic and order management systems for firms that own fixed income. More than 5 percent of the world’s financial assets are run through or analyzed by systems developed by BlackRock. No single investment bank, not even JPMorgan, can match this. Take a look at what the BlackRock product brochure says about the group that does client portfolio analysis – the very same group that helped the Federal Reserve Bank of New York value the assets it purchased from Bear Stearns when that firm collapsed:

The Portfolio Analytics Group (PAG) is a risk and analytics group in BlackRock Solutions that utilizes sophisticated analytics on fixed income, equity and alternatives businesses to help our clients and portfolio managers understand their portfolio exposures, strategy, risk and returns. PAG provides the daily risk reporting and ad-hoc analytical support to over $7 trillion worth of assets under risk management across thousands of portfolios. Analysts will gain a broad understanding of the asset and risk management business, which includes learning about the wide range of securities our clients trade, how they are priced in the market, how we analyze them within BlackRock Solutions and what sensitivities they have to various market factors.

BlackRock is deeply involved in the business of a lot of financial players. It has long been trusted with providing information on securities pricing and on the effect of market changes on client portfolios. For those clients using its Aladdin investment management system, there already is a built-in connection to the over-the-counter markets to execute bond trades with other brokers and ECNs (electronic communication networks, or trading platforms — see the box titled “Trade Execution” in the diagram). This built-in trade plumbing makes it painless for its clients to connect to Aladdin Trading.

The situation is a win-win for clients: They get to keep all their current ECN connections to Tradeweb and MarketAxess and all their plumbing to the various broker-dealers with whom they do business. Aladdin Trading is an add-on that will require minimal effort to use and will save clients the 50-to-75-basis-point spread they usually pay a dealer to execute a trade.

Of course, there are regulatory questions surrounding Aladdin. It really is just another “dark pool” that will “cross trades” between willing buyers and sellers. However, the price at which the trades are crossed must be made public. Beyond the need for market transparency, most of BlackRock’s clients are fiduciaries for public entities – sovereign wealth funds, pension funds and so forth – so a form of audit or disclosure on these trades is vital. BlackRock itself would be well-served to disclose these prices publicly in addition to reporting them to the aggregated FINRA TRACE tape. Disclosure would attract additional liquidity to the Aladdin platform. Bond trading is barely regulated, and BlackRock could set an important market standard with this move.

Aladdin has a new lamp. It will, one hopes, bring light to a dark part of the market.

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