September 25, 2013 1:52 pm

Q&A: Interdealer brokers

What is an interdealer broker?

It is a company that sits between investment banks helping find buyers and sellers of large, usually illiquid blocks of securities at other investment banks or dealers. The hours are long and intense, lasting from 7am until after the market closes. An interdealer broker is at his desk and on the phone all of the trading day, assessing prices, taking calls and making offers on assets usually traded off-exchange. They can trade large blocks of shares but mainly deal in assets such as interest rate and currency swaps, as well as commodities. The broker will take commission for arranging trades.

There are five main global interdealer brokers: ICAP, Tullett Prebon, Tradition, BGC Partners and GFI Group. Many were founded in the 1980s as trading globalised and investors increasingly turned to tailored hedges such as interest rate or currency swaps to offset risk. About 70 per cent of the global business is conducted either in London or New York.

Why are they involved in the Libor scandal?

Interdealer brokers do not participate in the daily London interbank offered rate-setting process, although some of the products they do trade are based on it. However, their roles as intermediaries make them key conduits in the market for information for other banks.

A broker will typically have several screens of data on his desk plus more information coming through on a telephone as well as an internet-based chatroom or instant messaging system such as Bloomberg or Reuters connecting him to his main customers at the banks. Through these electronic channels flow an unending stream of news, market sentiment, jokes and industry gossip. It was these messages that formed the backbone of regulators’ investigations and criminal charges. They allege traders were making inaccurate submissions to affect the setting of the daily Libor rate.

Has only ICAP been involved in the inquiry?

No, a small UK broker called RP Martin is also the focus of the global regulatory investigations. Two RP Martin employees were arrested by the UK’s Serious Fraud Office in December.

Is the Libor scandal a blow to their businesses?

As interdealer brokers do not set Libor, they do not have the same financial pressures as a bank. Nevertheless regulators have alleged that some brokers benefited from Libor rates being manipulated, being repaid in a variety of ways such as client entertainment, regular invoiced payments or so-called wash trades – in which buy and sell trades cancel each other out, simply to allow the IDB to collect commission.

However, the Libor scandal may have other long-term consequences. The economics of the business has been under pressure for several years as steady low global interest rates curb market volatility, and more business moves from the telephone to screen-based trading. Those trends have been exacerbated by a global regulatory push to force more OTC trades to be traded on transparent, anonymous trading venues. Here they face competition from new entrants to the market, such as exchanges.

The industry has said the sweeping global regulations tightening derivatives trading formalises their position as key components of modern markets infrastructure.

As global regulators continue to face public pressure to clean up financial markets, other benchmarks that are set by trading on the OTC markets, such as oil price setting, face further investigation. The industry may yet face a further regulatory clampdown.

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