Hedge funds will need to take more execution risk in derivative and bond markets as the Volcker rule remakes how banks and their clients trade with one another, said Michael Gooch, chief executive officer of GFI Group Inc. (GFIG)
Hedge funds and asset managers have traditionally relied on their dealer banks when they wanted to buy or sell bonds. The Volcker rule, part of the Dodd-Frank Act regulatory overhaul, bans proprietary trading by banks. As a result, firms have cut their inventory of corporate bonds to almost their lowest levels since 2002, making it harder for investors to easily and cheaply buy and sell debt.
BlackRock Inc., the world’s largest money manager, said in April that it plans to start a bond-trading system that will allow investors to bypass investment banks by matching clients’ orders rather than relying on Wall Street firms or other electronic networks to trade bonds. Goldman Sachs Group Inc. began its GSessions trading system last month to match customers’ demand to buy and sell corporate debt.
GFI Group, based in New York, has offered matching sessions in corporate bonds and derivatives for two years, Gooch said.
“The banks are going to be in a different role going forward,” he said. The opportunities for banks to make money from their clients will shift to clearing and execution services in both bond and derivative markets, he said. With banks and their customers such as hedge funds and asset managers all seeking out trades, the amount of revenue from the transactions will become more competitive, Gooch said.
“Without a doubt there will be fee-splitting,” Gooch said.
Money managers such as BlackRock and Pacific Investment Management Co., which owns the world’s largest mutual fund, won’t be willing to replicate the bank role of taking either side in bond or derivative markets, Gooch said, though they will be willing to express interest in one side of a trade they like.
“Liquidity will evolve from end users in the long run,” he said.
To contact the reporter on this story: Matthew Leising in New York at firstname.lastname@example.org.