Thursday, 30 March 2017
Last updated 4 hours ago
May 11 2016 | 3:03pm ET
The application of technology to financial markets has revolutionized countless aspects of investing and trading, from things as simple as online quotes to dark pools and extraordinarily fast algorithms that can move more stock, currencies or derivatives in an instant than most of us will trade in a lifetime. For years, technology has slowly but surely replaced the age-old back and forth between buyer and seller, inching investors closer to what many hope will eventually be “perfect” markets – those with the smallest possible spreads between bids on the one hand, and asks on the other.
However, second perhaps only to the diehards in the open-outcry futures pits, the institutional bond market’s traditionally high-touch style of trading has proven to be a tough nut to crack. Much of what can make or break an institutional bond trade is still delivered via the nuances inherent in an antiquated system of phone calls and relationships. It’s as if the technology that has truly revolutionized virtually all other securities markets – equities, options, futures, even swaps – has skipped the bond market, meaning countless billions of extra costs and inefficiencies remain embedded there.
Enter Electronifie, an all-to-all, non-attributed electronic exchange for institutional bond trading. Built from the ground up to directly address the elements of bond trading that have kept much of the market in the proverbial dark ages, Electronifie provides clients with a way to electronically trade bonds quickly and in size while simultaneously limiting information leakage.
Inventing a better mousetrap
To be fair, electronic trading in bonds is nothing new. E-Speed pioneered it decades ago, and MarketAxess now dominates the sub-$1 million trade customer-to-dealer market. But Electronifie has it sights set on the larger portion of the institutional market where trades often run into the tens of millions apiece, and investors rarely, if ever, interact with one another. It is this segment of the market that Electronifie’s platform has been designed to revolutionize.
Electronifie was founded in 2014 by former Goldman Sachs credit trader Amar Kuchinad, who also did a stint as a senior policy advisor to the SEC’s Division of Trading and Markets. Kuchinad spent much of 2013 on the road speaking to market participants figuring out how to improve the process without changing the typical trader’s workflow. “The last decade was defined by financial technology that was cool, but didn’t necessarily solve a problem,” Kuchinad says. “Meanwhile, regulatory change means big banks are backing away from the market-making business, impacting liquidity, pricing, execution speed, etc.”
“We knew from the beginning that our system would need to replace instant messaging and phone calls as the primary means of price discovery and trade negotiation, but the trick was to design a platform that makes the change in the form of communication seamless for the trader,” he continued.
Electronifie’s marketplace allows a trader to advertise their interest to trade a particular bond without having to expose it in such detail that it will be subjected to front-running and other predatory trading activity. While the platform is anonymous and all orders are non-attributed, traders can choose the level of detail to share about the size and price of their orders, and can even choose whether or not to reveal that they are buyers or sellers of the issues in question. Unlike traditional dark pools which rely on two or more users to have coincident buy and sell orders on the same bond at the same time, Electronifie’s smart notification functionality serves as a “virtual salesperson” and notifies traders of activity that it has determined should be of interest to them. If one or more of those traders in turn expresses their interest and it aligns with the initial order entered, a trade is executed instantaneously, like in the equity market.
“The user maintains control over how the order is disseminated and how much information about it is known,” explains Kuchinad. “We maintain enough control so the integrity is there. There are no ‘indications’ – every order is live, there is no spoofing or backing away.”
Stopping the leaks
In other words, there is none of the infamous information leakage, the “did-you-hear’s” and fishing expeditions that characterize the large block bond-trading world. Additionally, market impact is minimized – traditionally, a trader trying to sell a large chunk of bonds will start calling around to a list of counterparts that might be interested. Depending on who the seller is, the issue and the size, word about the impending sale can circulate extremely quickly and push down the price.
For anyone who traded through the Lehman collapse, the implications of such systems are obvious. A worrisome lack of dealer inventory or willingness to provide liquidity, coupled with elements like ETFs, suggest that another tidal wave of bond selling could result in a severe mismatch, blowing out spreads and causing the market to seize up again. All-to-all platforms such as Electronifie can play an important role in containing such volatility, both as a source of liquidity but also limiting the spiraling effect of major market moves. On Electronifie, the identity of sellers is masked, so the dumping of a very large position by a well-followed bond manager is unlikely to lead to a mad rush for the exits, whereas pre-crisis, it would have been all over the Street in seconds.
“Technology can protect trade information better than people can,” added Molly Himmelstein, Electronifie’s marketing manager. “It’s much safer. There is a lot of faith in the platform, since everyone is on a level playing field. All order information is unattributed.”
Kuchinad points out that what his team has built is not trying to replace human interaction in the trading process. “We’re not talking about taking humans out of the equation, just making it easier for them to work. We’re trying to reduce the friction cost of trading by eliminating high-touch, low-value-added activity.”
They also designed the platform to look familiar to the new generation of traders. “We have some clever technologists in house that make apps that are easy to use and look familiar to our clients.” At the same time, Kuchinad – who studied applied mathematics at Harvard University and is an avid student of game theory – has worked tirelessly to eliminate ways for traders to game the system. Accordingly, Electronifie has been built around rule sets with embedded incentive mechanisms to keep them from trying.
Unsurprisingly, Electronifie’s business has grown rapidly in the past year. An ATS for regulatory purposes, the company averaged $200 million in trades per month in the first quarter, and did $250 million in March. Its customers are large asset managers, including three of the top five asset managers as ranked by Institutional Investor, and 40 of what Kuchinad calls “real money” accounts – insurance companies, 40-act mutual funds, etc.
At the moment, hedge funds are a relatively small part of his business, but ones he believes will grow as the network effect of what Electronifie is doing spreads. “The departure of big banks from risk-taking and market-making has put a lot of former sell-side traders into the hedge fund business,” Kuchinad says. “If you are a short-term trader, we provide a great avenue for you to get paid for providing liquidity without having to pay a huge sales force to do it.” And interestingly, broker-dealers are a growing element, since although the platform is built for principals to deal with each other directly, dealer participation is important in order for asset managers to meet the compliance requirements of buying and selling at the best inside price.
And as with any good technology company, Electronifie pays very close attention to what its customers like and want, making tweaks to the system on a regular basis.
“Almost from the start, clients started asking for similar functionality in structured products,” Kuchinad explained. “It’s an area we are looking at because the platform fundamentally works for anything traded OTC. Anywhere dealers are not providing immediate liquidity, we can provide an alternative means of connecting buyers with sellers in a more-controlled process.”
Kuchinad is also candid about what he’s learned about the platform from clients, especially those that were trading though the intense volatility earlier this year. “Some of our clients have said the markets were too volatile to leave an order sitting on an electronic platform,” he explains. “Clients wanted something that will give a quicker response on whether an order is filled within a specific window, so we have implemented some changes to adapt.”
Another suggestion from the trenches is sourced straight from the millennial generation. “Traders have told us they’d like to know, for instance, the five bonds on which they should be focusing. It would save them time. We’re taking a page from the likes of Spotify and Pandora, using a lot of fuzzy logic around preferences, searches, trade history etc. to narrow the range of bonds that should interest you, as well as determining which traders will see those bonds if and when you put an order out there.”
Electronifie raised $17 million in three rounds of funding and is now seeking an additional $5-$15 million. “This requires depth and patience and a runway,” Kuchinad says. “It takes time to change behavior.” The company steadfastly refuses to voice-broker trades, for instance, although it would be a lot easier for them to place some trades the old fashioned way. “That’s the greedy play. We want the market to use – and trust – our platform.”
More information about Electronifie, including a demo, is available here.