Capital Markets
Fundamental Brokers Inter-Dealer - Business Description
Broker/dealers and other financial institutions utilize the secondary fixed income markets to execute their customers’ orders, trade for a profit and manage their exposure to risk, including credit, interest rate and exchange rate risks. There is no centralized exchange in the fixed income market. As a result, financial institutions need a way to find information, liquidity and anonymity for their trading activity. This need created a demand for the services of perhaps the least known and understood market participants, interdealer brokers (IDBs).
IDBs in the secondary government, agencies, corporate and other debt markets — also known as “Broker’s Brokers” are specialized securities companies who act as intermediaries working to facilitate transactions between broker/dealers and dealer banks in these markets. IDBs help to provide liquidity in the bond markets. That is, they provide an environment wherein market participants can ascertain information about a given market, which may eventually facilitate a trade between buyers and sellers.
THE MARKETS – Fundamental Brokers Inter-Dealer (“FBI”) distributes information and facilitates transactions in the secondary, or wholesale, financial debt markets between dealers and dealer banks around the world. Although market participants often refer to a single “bond market,” there are actually quite separate markets, which include: (1) high grade sovereigns, including the U.S. government and G-10 foreign governments, (2) U.S. federal agencies and government sponsored enterprises (“GSEs”, and, collectively with federal agencies, “Agencies”), (3) corporate debt, (4) Agency and non-Agency mortgage backed securities (MBS) and asset-backed securities (“ABS”), including collateralized debt obligations (“CDO”), (5) high yield securities, such as high yield corporate debt, distressed debt and emerging markets debt, including emerging markets sovereigns, (6) municipal securities, and (7) interest rate, credit and other derivative products. Typically, markets, which make extensive use of IDBs, include the corporate bond, fixed income derivatives, U.S. Government and Agency, municipal securities and emerging markets. Dealers seek out IDBs with expertise in the securities they seek to trade in, so that they can test trade ideas against what may be possible in the market at any given time.
THE ROLE OF FBI – FBI plays varying roles in each of the fixed income markets by attracting buyers and sellers so that trades can be executed by market participants.
In general, terms, FBI adds value to the markets by:
- Enhancing price discovery;
- Providing anonymity and confidentiality;
- Facilitating information flow;
- Facilitating enhanced liquidity;
- Improving market efficiency; and
- Lowering costs.
Enhancing price discovery and transparency - In connection with our facilitation of transactions, we provide pre-trade price discovery. Prior to execution, FBI distributes its dealer
quotes, in the form of bona fide bids and offers for securities through a variety of methods ranging from our custom-designed trading platform to voice and e-mail communications
Usually we aggregate quote information in order to show our dealer clients the “best” quotes available in the market place. Dealers use this information to trade for their own account and to facilitate customer transactions. In this way, FBI provides analogous services for the fixed income markets as the consolidated quotation system provides for the equities markets.
FBI also provides information to dealers about the depth of the market, for example providing different quotes based on the par value of a particular security being bid or offered.
Providing anonymity and confidentiality - Pursuant to industry practice and regulation, the relationship between a dealer and FBI is a confidential relationship. FBI maintains participant anonymity concerning broker/dealers and dealer banks during the price discovery process in the sale and purchase of bonds.
During price discovery, dealer interactions with us mask the identity from the marketplace. This anonymity reduces the market impact costs associated with the value to the market of the knowledge that a particular dealer is seeking to buy or sell a specific quantity of bonds. For example, a large bank or dealer may be looking to acquire or sell a large amount of inventory. If done directly, such massive trades may well affect market levels, with consequent negative impact on the dealer’s trading strategy. By transacting their business through FBI, the initiator of trading activity remains anonymous. In addition, the large quantity of bonds can be sold in smaller lots, thus maintaining a stable market and uniform price throughout the transactions.
Facilitating information flow – FBI plays a significant role in facilitating the flow of information between dealers, this critical service enhances liquidity and results in improved prices for market participants.
While providing anonymity to FBI’s dealer clients, we encourage dealers to supply us with market information, typically in the form of calls received seeking bonds or from those looking for a buyer of their bonds. Accordingly, we are able to provide participants with valuable information that reflects the buying and selling interest in the bonds among dealers.
FBI also facilitates post-execution price transparency. For example, after a bid-wanted trade is executed, we may provide a dealer with information about the “cover” bid, i.e., the next best bid after the level at which the bond traded. This is important information for dealers to have in assessing the depth of the market and the risk involved in bidding or offering bonds at particular levels. This information permits dealers to quote markets with better certainty, and presumably at lower spreads, increasing secondary market liquidity and the ability for investors to sell their bonds.
Enhancing liquidity - Regardless of the particular financial market, several factors affect market liquidity: issuer’s name, issuer’s credit rating, outstanding size of the particular issue and the total size of other issues outstanding from the same issuer.
FBI provides dealers with quotes from other dealers, thereby enhancing the information available to the market and the market’s overall efficiency. In addition, FBI participates in certain marketplaces by posting quotations for its own account and by acting as principal on unmatched trades to facilitate transactions, add liquidity, increase revenue opportunities and attract additional order flow. Thus, FBI facilitates trades and ensures a liquid market.
In addition, traders’ multiple responsibilities often include managing their firm’s risk, dealing with customers in addition to investigating new market opportunities. As a result, they often look to FBI to support them on the market side with their specialist knowledge.
Improving market efficiency – FBI helps its dealer clients save time. For traders, time is of the essence, because trading activity does not typically occur with regularity. As a result, traders enhance their profitability by making the greatest possible number of bond trades per day.
Regardless of the market, when a trader is looking to participate in a given market, time is critical. Accordingly, FBI must have up-to-the-minute knowledge of market participants’ activity, and must be available to dealer/ traders at a moment’s notice. For traders, the timesaving element of working with FBI may easily make the difference between executing and missing a trade.
Lowering Costs - By collecting information from dealers on an independent basis, we are able to provide our dealer clients with an assessment of the liquidity available for a particular bond series. This function serves to make available a market value for often-illiquid securities and serves to lower search costs for broker-dealers. Without providing this information, brokers and/or dealers would be in the position of having to expose their identity to the marketplace as they search for liquidity. This would only serve to impair their bargaining position and raise their costs, as inevitably the information would be used against them in the marketplace.
FBI brings together and executes transactions for buyers and sellers of bonds. The transactions may be effected on an agency basis. We use our knowledge of market “color” to assist in the price negotiation process and to bring together buyers and sellers. This service brings the market together and provides broker-dealers with efficient matching.
FBI clears all transactions through Ridge Clearing and Outsourcing Solutions, Inc. (“Ridge”). Pursuant to a Principal Letter issued to our accounts by Ridge, Ridge will act as principal on most (if not all) of our transactions.
PRINCIPALS
ROBERT V. GUBITOSI—President
DAVID J. HILL—Managing Director
PAT GORDON – Co-head of Mortgage-Backed Trading
DON REYNOLDS - Co-head of Mortgage-Backed Trading