Why Wells Fargo Finally Joined the Bond World's Most Select Club

  • Central banks said to prefer transacting with primary dealers
  • Yet cachet eroded by regulatory strain, trading executives say

At a time when Wall Street banks say they’re running out of reasons to trade with the U.S. government, Wells Fargo & Co. is jumping into the market.

For Wells Fargo, though, it’s not so much about dealing with the U.S. itself as it is about the other major clients that can be won over once a bank has earned its primary-dealer credentials. The world’s central banks, a growing force in bond markets everywhere, prefer to trade with institutions that are designated trading partners with the Federal Reserve. People with direct knowledge of Wells Fargo’s decision said that it was this sizable investor group that prompted them to sign up.

“There are some large investors that will only do business with a primary dealer,” said Kevin McPartland, head market-structure analyst with financial-services consulting firm Greenwich Associates. “The intangible credibility that comes along with that is valuable.”

The brokerage arm of Wells Fargo became the 23rd primary dealer on April 18, joining a select group that bids at Treasury auctions and helps the Fed carry out policy. The role’s trading opportunities should be a boon at a time when the European Central Bank and the Bank of Japan are buying debt to stoke economic growth, while countries from China to Saudi Arabia have been burning through foreign reserves to defend their currencies or raise much-needed cash.

Still, Wells Fargo is making the move as other Wall Street banks balk at the responsibilities that come with the title. The dealer role isn’t as lucrative as it used to be, according to three current and former heads of trading desks. Wells Fargo is the first addition to the list in over two years, and the group is down from a high of 46 in 1988.

Lost Cachet

Before the financial crisis, primary dealers acted as underwriters for most of the U.S. government’s debt issuance, and were the main private-sector trading partners of the Fed. These days, dealers aren’t the main buyers of Treasury auctions. And regulatory balance-sheet restrictions make it more of a burden to bid for their pro-rata share of Treasury auctions, traders say. A total of $2.1 trillion of debt was auctioned in 2015, according to the Securities Industry and Financial Markets Association.

“Auctions reveal what is a common theme in today’s market: the diminution of the primary dealer’s influence,” wrote representatives from Daiwa Capital Markets, a primary dealer, in an April 22 response to a Treasury Department request for information about the evolution of the $13.4 trillion market.

Dealers bought 35 percent of Treasury auctions last year, down from 67 percent a decade ago, according to data compiled by Bloomberg. Investors who bid directly with the Treasury bought 10 percent of new debt last year, totaling nearly $200 billion. A decade ago, they bought 1.1 percent of new securities, or $7.5 billion.

What’s more, the Fed started trading with a broader range of firms when it moved to raise interest rates last year. To keep its benchmark borrowing rate above 0.25 percent, it started to offer reverse repurchase agreements directly to 13 government-sponsored enterprises and more than 100 money-market funds. Less than a third of those money-market funds are managed by divisions of banks that also serve as primary dealers.

Changing Landscape

Wells Fargo became a primary dealer to help advance an expansion of its bond-trading business, according to the people familiar with its decision, who asked not to be identified because they’re not authorized to speak publicly on the matter. The bank was already one of the top 20 Treasuries-trading partners for money managers before it earned the status, according to early 2015 data from Greenwich Associates. It’s also the 10th biggest underwriter of investment-grade corporate debt this year, according to data compiled by Bloomberg.

“The scope and scale of what we’ve been doing, it’s been at the level of a primary dealer for a long time,” Elise Wilkinson, a spokeswoman for Wells Fargo, said last week. She declined to comment further on the timing or motivation of the move.

Yet bond trading has become more challenging, even in ultra-safe Treasuries. While investors still do most of their transacting with primary dealers, high-speed electronic trading firms have taken a bigger share of dealer-only platforms, according to a July government report. That makes it tougher for banks to offset their exposure to clients’ positions. The people familiar with Wells Fargo’s move said that the bank is building out its electronic-trading capabilities.

Primary dealers are also facing new competition from automated trading firms such as Citadel Securities, which recently started offering to trade one-on-one with money managers.

Wells Fargo is “very concerned with the current emphasis on speed of execution,” since it could make it tougher for investors to make large Treasuries trades, two of the bank’s trading executives wrote last week in response to the Treasury Department’s request for information.

Regulatory Review

Regulations introduced after the financial crisis give an “incentive to utilize available balance sheet capacity on higher yielding spread product assets,” such as corporate debt, “and not U.S. Treasuries,” wrote C. Thomas Richardson, the bank’s head of market structure and electronic trading services, and Cronin McTigue, head of liquid products.

Still, Wells Fargo’s strong balance sheet and new-entrant status should help it handle the pressures of a changing market better than other banks, said McPartland of Greenwich Associates.

“The dealers that have been in the market for a long time have been forced to go through a restructuring of their people and processes,” he said. “Coming at the market fresh gives Wells the advantage of building out their business knowing what we know today, instead of having to retrofit it.”

The following is a table of current primary dealers:

Bank of Nova Scotia, New York AgencyJ.P. Morgan Securities LLC
BMO Capital Markets Corp.Merrill Lynch, Pierce, Fenner & Smith 
BNP Paribas Securities Corp.Mizuho Securities USA Inc.
Barclays Capital Inc.Morgan Stanley & Co. LLC
Cantor Fitzgerald & Co.Nomura Securities International, Inc.
Citigroup Global Markets Inc.RBC Capital Markets, LLC
Credit Suisse Securities (USA)RBS Securities Inc.
Daiwa Capital Markets AmericasSociete Generale, New York Branch
Deutsche Bank Securities Inc.TD Securities (USA) LLC
Goldman, Sachs & Co.UBS Securities LLC.
HSBC Securities (USA) Inc.Wells Fargo Securities, LLC
Jefferies LLC

Source: Federal Reserve Bank of New York

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