Demise of Direct Match Shows Bank Death-Grip on Treasury Market

  • Trading startup couldn’t gain access to key industry utility
  • Contrasts with ease IEX had breaking into U.S. stocks

Direct Match Holdings Inc., which aimed to be an alternative to bank dominance in the $13 trillion U.S. Treasury market, died before it arranged even one trade.

The New York-based startup wanted to give hedge funds and asset managers the same type of anonymous, exchange-style trading that banks and sophisticated electronic firms have enjoyed for years. The problem: Direct Match needed to partner with one of those banks to access the Treasury market’s clearing-and-settlement plumbing. State Street Corp. initially agreed to such a deal, then canceled it, dooming Direct Match.

Banks still dominate Treasury trading and get to act as gatekeepers that can block potential competitors, unlike other major markets like U.S. stocks. IEX Group Inc. just opened the nation’s 13th stock exchange, a year after seeking regulatory approval. It didn’t need a bank partner to get wired into the market. With Treasuries -- one of the world’s key assets -- Wall Street’s biggest banks still pull the strings.

“Until more attention is paid to the plumbing of the U.S. Treasury market, startups will struggle to bring innovation to the marketplace,” Jim Greco, a co-founder of Direct Match, said in an interview. Greco outlined his struggles with Direct Match, which shut down before completing even a test trade, in an essay published by Business Insider on Aug. 23. “In our conversations with regulators, we encouraged them to establish fair and consistent rules for centralized clearing that will expand access to the market and enable greater competition among venues,” he added during the interview.

Anne McNally, a State Street spokeswoman, declined to comment.

Dealers and Clients

About $500 billion of Treasuries trade each day, according to the Securities Industry and Financial Markets Association. Just under half of that takes place one-on-one between dealers and their clients, according to a report last year by the Federal Reserve Bank of New York. This segment is dominated by five banks that control 60 percent of volume, up from 44 percent a decade ago, according to consulting firm Greenwich Associates, which didn’t name the firms.

It’s an opaque market, where the size and price of trades are known only to participants in the transaction, making it hard for investors to know whether they’re getting a good deal. Trading can be done over the telephone or through electronic auctions hosted by Bloomberg LP, the parent of this news organization, and Tradeweb Markets LLC.

The rest takes place on electronic markets owned by ICAP Plc, Nasdaq Inc. and Tradeweb. Here, the size and price of trades are known to all users of the system, which are mostly Wall Street dealers and automated trading firms such as Jump Trading LLC.

Different Path

Greco, who had worked at investment bank Jefferies and automated trading firm Getco, wanted to forge a different path. He said constraints on Wall Street dealers after the financial crisis created an opportunity for a trading platform available to investors and trading firms. If successful, it would erode the barrier between the newer, technologically sophisticated trading firms and investors, though likely to the detriment of the banks.

For his vision to work, he needed a way to clear and settle trades. That’s a key back-office function that provides a buffer between traders should one of them default. That system also handles the exchange of cash and securities. That plumbing resides inside Depository Trust & Clearing Corp. at a unit called the Fixed Income Clearing Corp. FICC, as it’s known, is the only clearinghouse for government bonds.

To join FICC, a startup like Direct Match faces insurmountable odds: a significant amount of capital and six months’ experience running a profitable business among a host of other rules maintained by DTCC. That’s why it had to partner with a bank, which would serve as a conduit into the system. Direct Match had a deal with State Street until the bank canceled it earlier this year.

Among the nearly 150 banks and brokers that make up the FICC, only three are willing to grant access to the clearinghouse for outside firms like Jump Trading or Direct Match, according to people familiar with the matter.

Tumultuous Period

The Treasury market has been through a period of controversy and tumult in recent years, including allegations of manipulation. Last year, people familiar with the matter said the U.S. Justice Department was investigating whether information was being improperly shared by financial institutions that serve as the market’s backbone. In October 2014, the biggest yield swings in a quarter century undermined investor confidence.

Regulators have taken notice. The Treasury Department, Securities and Exchange Commission and other U.S. government agencies are in the middle of assessing how the market should be overhauled to accommodate modern trading. That’s the first government review since 1998. The SEC is separately considering a requirement that Treasury trades be reported to the regulators at the end of the day.

To read more about the attempt to reshape the Treasury market, click here.

DTCC also runs the clearinghouse for U.S. stocks. IEX only needed regulatory approval, not a bank gatekeeper, to get its exchange going, a sign the barriers to entry into the $24 trillion U.S. stock market are far lower.

DTCC declined to comment on Direct Match.

Even with the demise of Direct Match, there are signs that the market continues to change, and that banks’ dominance will still be challenged. Some market makers that aren’t banks are looking to connect directly with investors, which would strip out the dealers entirely, according to the Bank for International Settlements. Citadel, which describes itself as a global market maker, is looking to do just that.

“We are very focused on growing our U.S. Treasury dealer-to-client business,” said Paul Hamill, global head of fixed income, currencies and commodities for Citadel Securities. “We are working on some direct connections to clients right now.”

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