Communications Gap Stymies Fixed Income

Terry Flanagan

The attention on high-frequency trading surrounding Michael Lewis’ book Flash Boys is putting the spotlight on information, in particular the speed through which it flows through the financial system.

Whereas HFT measures speed in milliseconds, there are other parts of the market where speed might be measured in days or even months, as with illiquid markets.

In fixed income, for example, there are situations apart from bond trading that require precise information, such as voting rights, where it’s necessary to locate the bond’s beneficial owners, according to Mike Manning, CEO of DealVector.

“It seems like a very simple and fundamental issue, but it’s a big hole and problem in finance that issuers don’t know who their investors are,” said Manning. “This really creates all of the other dysfunction that goes into fixed income markets.

DealVector focuses on the fixed-income markets, in particular, areas of fixed income that are the least liquid and often the most prone to voting and control rights issues. These include the corporate bond market as well as structured finance–the ABS and MBS, CDO and CLO markets. These segments alone are notionally bigger than the U.S. public equity markets.

“What our platform does, it essentially creates an infrastructure which allows players in these markets to connect with each other and find each other much like needles in a haystack. This is important because it really gets to the core central problem of the fixed income markets,” said Manning. “It’s sort of the opposite end of the spectrum of this high frequency trading stuff, but it’s very much akin to it.”

The vast majority of publicly traded shares in the United States are registered on companies’ books not in the names of beneficial owners, but rather in the name used by The Depository Trust Co. (DTC). Shares held in this manner are referred to as being held in the “street name.”

The street name registration system was created to facilitate securities trading, eliminate paperwork, and preserve the confidentiality of beneficial owners’ identities.

DTC holds shares on behalf of banks and brokers, which in turn hold on behalf of their clients, who are the beneficial owners. Because DTC acts as custodian of the shares, and has no beneficial interest, a number of mechanisms have been created to transfer its legal rights down to the beneficial owners.

“The imposition of street name system did wonders for solving the paperwork crisis on Wall Street in the 70’s and allowed the settlement of two quadrillion dollars’ worth of trades,” said Dave Jeffords, chief operating officer of DealVector. “But it’s had the side effect of making communication virtually impossible.”

Although the problem is probably most intense in structured credit, it’s a universal characteristic of all financial instruments. “While it’s a great system for settling quadrillions of dollars in trades every year it’s got this side effect of completely divorcing people from ownership information,” said Manning. “IBM, for example, doesn’t know who most of its bond holders are. That’s true with all issuers.”

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