As a trader at Bank of America, Richard Prager helped develop a computer system that allowed retail customers to hedge their fuel needs in a similar way that big companies are able to do through complicated derivatives trades.
Now, three years after joining BlackRock, Mr Prager is using his technological creativity to expand the role of the world’s biggest asset manager in the capital markets, where trillions worth of securities are created and traded every day.
In doing so he is tiptoeing into an area that has traditionally been dominated by Wall Street’s biggest banks – the corporate bond business.
“We’re all changing roles a little bit, evolving to the new environment,” says Mr Prager, now BlackRock’s global head of trading.
Many bankers have dismissed the notion of a significantly expanded role for “buyside” investment groups in the capital markets. Mr Prager says he is filling a hole left by investment banks as they shrink their business lines and balance sheets.
For years banks held vast inventories of corporate bonds in order to buy and sell the securities to investors. The image of dealers barking orders over the phone to their trading partners became synonymous with Wall Street.
However, new regulation including Basel III regulatory capital standards, and the Volcker rule which bans proprietary trading by banks, has made holding big inventories of bonds a more expensive and trickier feat for banks. Inventories of bonds held by dealer banks has slumped to $45bn, down from a peak of $200bn just before the financial crisis and the lowest level in more than a decade, according to Federal Reserve data.
BlackRock is hoping to plug some of the gap left by retreating banks with a new electronic trading platform for corporate bonds known as the “Aladdin Trading Network”. The system will allow buyers and sellers of such debt, including buyside groups, to trade directly with each other instead of going through a bank.
“The buyside wants to be able to trade credit. As soon as interest rates increase that’s going to make their net asset values deteriorate. They want to be able to get in and out of these positions,” says Will Rhode at consultancy Tabb Group.
“You know the old saying, liquidity begets liquidity,” says Mr Prager. “It’s not a silver bullet, it’s just one of the several different responses we have.”
Bankers are divided about whether corporate bonds – which are far less standardised than stocks – are suited to the same kind of electronic trading that revolutionised the equity markets more than a decade ago. But even some of those who believe bonds are inevitably heading towards “equification”, as new technology comes into play, are doubtful that BlackRock’s own platform can succeed.
Many cite the difficulty of successfully “making markets”, or perfectly matching buyers with sellers, when it comes to corporate bonds. Others say that smaller investors may be hesitant to purchase bonds on a platform built by BlackRock – a company that claims to hold 6 per cent of all the investable assets in the world.
BlackRock thinks “it’s a great idea and believe that they will have no problem supplying liquidity and circumventing the dealer community, then things get tricky and they put their hands in their pockets”, says one corporate bond trader. “It’s a bit like poker, if you don’t know who the rube is at the table it’s you.”
Some bankers are still debating whether corporate bonds, which are not as standardised as stocks, are suited to trading on big electronic platforms.
“Yes, parts of fixed income are definitely different; but every time I hear the words ‘it’s different’, we have to stop and ask ‘how much and why?’” says one.
But BlackRock’s ambitions extend from beyond how the bonds are traded in the secondary market and all the way to how they are issued. The asset manager’s capital markets desk, a business line traditionally found in investment banks, is said to have been busy in recent months. The asset manager earlier this year asked a number of corporates to issue more debt through so-called “reverse inquiries”.
Mr Prager says emphatically that he is not trying to disintermediate the banks or cannibalise their fees.
“Everyone’s economics are very complementary but instead of having a model whereby the Street originates and then distributes products to investors like BlackRock – our capital markets function allows us to be at the table ahead of time,” he says. “That ensures BlackRock the inventory and quality of assets that we want, and that helps the banks’ returns by having them deploy less capital. So for them, instead of having to underwrite a billion dollar deal, we’re there for $500m.”
Still, the foray into investment banking territory has not gone unnoticed by banks.
“They’re going to build a big client-facing network and stabilising network and commit balance sheet, then they will be another number in the long list of boutique firms that have a capital markets network,” says one senior banker at a large US bank. “They’re still going to be a big customer for banks. They’ll still need them.”
While some bankers may disregard BlackRock’s ambitions, they nevertheless speak to a key development. As banks are being increasingly reined in by new regulation, buyside groups find themselves with a wider range of opportunities.
“Regulators are collectively trying to de-risk these financial institutions; they’re going back to basics and now you can sell basics with machines,” says Mr Prager.
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