Bloomberg is not exactly a new face in the swaps market, but post-crisis reforms have allowed it to dramatically expand its influence. While its customers will welcome this, detractors claim the company’s terminals business allows it to undercut competitors, and creates an incentive for it to obstruct third-party service providers. By Peter Madigan For $10, you can buy a nine-piece chicken bucket at KFC, a MetroCard worth four bus or subway rides in New York, a month's worth of cloud data storage or – if you happen to have a Bloomberg terminal – an interest rate swap of any notional size or maturity. Admittedly, this is only Bloomberg's per-trade cost – users need to pay a bid-offer spread as well, with clearing costs on top – but it is a tiny fraction of the fees charged by rival swap execution facilities (Sefs), which typically vary according to the risk posed by a trade. At TrueEX, this kind of pricing structure translates into a $900 charge for a five-year, $100 million interest rate swap, while the same trade would cost $990 at Javelin Capital Markets if executed on its central limit order book. Rivals say Bloomberg is able to undercut them because of the revenues generated by its near-ubiquitous terminals – the Bloomberg Professional service – which can be found on about 320,000 trader desktops worldwide. "If it was not being subsidised by its terminal sales, there is no way Bloomberg could operate at that price point. No other Sef can compete at that level. Think about the numbers: at $10 per trade, even if Bloomberg was transacting 1,000 trades a day – and there really are not that many interest rate swap trades in the US daily – that would only amount to $10,000. It must cost more than that to keep the Sef running for a day," says a source at one interdealer broker. The importance of the terminal to Bloomberg's business model is nothing new; what is newer is the firm's influence in over-the-counter derivatives markets, where its platform has quickly carved out a dominant position since Sef trading became mandatory for certain interest rate swaps and index credit default swaps (CDSs) in February. Between May 5 and June 6, a notional $1.03 trillion in interest rate swaps, foreign exchange swaps and index CDSs was executed between dealers and their clients on Sefs, according to data compiled by Clarus Financial Technology. Of that total, no less than $783 billion was executed on Bloomberg Sef – a 76% market share. Its nearest competitor, Tradeweb, handled $186 billion in volume – 18% of the overall market. Those two venues alone have 94% of all dealer-to-client flows (see figure 1). For buy-side firms, Bloomberg's presence in the Sef market is a good thing, as they gain a new service at no significant added cost, without having to acquire or adapt to new technology, but this worries some of the market's traditional powers. Unlike many other trading and infrastructure entities that have broken into the OTC market, Bloomberg is its own animal – neither owned by dealers nor brokers, it does not claim to be run for or by the industry – and its relationships with sell-side banks have occasionally been fractious. "Is it concerning that, three months in from the true beginning of the execution mandate, one Sef has north of 70% of the buy-side market share? Of course – that's a lot of pricing power – but we are focused on the opportunities down the road and not losing sleep over it; not yet at least," says one electronic trading specialist at a US dealer. So, how is Bloomberg using its new-found power? Predictably, there are critics. Equally predictably, few want to stand up and be counted. Many of these gripes can be ignored, yet some are worth a closer look. The pricing of Sef trades is one, but primarily because it illuminates the importance of the terminal, which comes into play in other allegations – that Bloomberg is currently unable or unwilling to support introducing broker trading models, for example, or that the firm has been slow to remedy problems processing package trades through third-party credit-checking hubs. In both cases, the belief in some quarters is that the firm sees these services as a threat to its business model. Bloomberg was given the opportunity to review these criticisms and responded with a short, written statement. "Bloomberg Sef charges both an access fee and transaction fee for its services, and offers impartial access to all market participants and independent software vendors. Consistent with the independent software vendor pricing model, Bloomberg pays Bloomberg Sef access fees for clients who utilise the Sef via the Bloomberg Professional service. This is core to Bloomberg's clients' workflow and consistent with providing them value." The firm does have its supporters on the sell side, including a senior, fixed-income trader at one large bank in New York, who says: "Where liquidity gathers is completely in the hands of the buy side and where they wish to trade, and that place is Bloomberg right now. No-one is forcing the clients to trade on Bloomberg – they have to provide a service people like." Obviously, people like services that are cheap, but there are reasons to think it may not have cost Bloomberg the earth to provide, in any case. First, the company might argue its Sef builds on technology already in place. Bloomberg has been providing electronic trading of interest rate swaps since 2003, in the guise of request-for-quote platform BBTI, and streaming prices for rate swaps and index CDSs on its ALLQ platform since 2011. So, the extra cost was low and the additional volume is thought to be significant – Bloomberg refuses to disclose its pre-Sef trading volumes, but a press release from 2006 boasts of single-week interest rate swap volumes of $47 billion, a record for the platform at that point. Second, the Sef runs no legal risk from a trade failing to clear – pre-trade credit checks mitigate the danger and if a trade is rejected post-execution, US regulation states it should be treated as void ab initio, meaning it never existed. This means the platform could argue it is ambivalent about the size of a trade and therefore does not need to vary its charges. Bloomberg's rivals are not buying it. Fellow dealer-to-client incumbent Tradeweb operates a tiered pricing model in which the ticket cost for a buy-side participant can actually drop below $10 per trade if the client trades in sufficient quantity, but market sources say this income is supplemented by membership fees in the region of $1 million a year for dealers quoting prices on the platform. Tradeweb declined to comment on the existence or size of dealer membership fees. "Bloomberg's business model is to keep adding value to the terminal service to make it indispensable to their clients. Making the terminal the entry point to their Sef, to the swap data repository (SDR) they have established, to their analytics, down to their instant messaging service, all these functions serve to increase client dependency on the terminal," says one interdealer broker. This kind of rough-and-tumble will always ensue when business models collide and one appears to have an edge that is difficult for its rivals to replicate, but some complaints go beyond pricing. From swap dealers to credit-checking utilities, critics cite instances in which Bloomberg's Sef has been unable to support a third-party service provider, ostensibly due to technological issues that will be ironed out as the new regime beds down. Some of these third parties claim the technological issues are a sideshow, and Bloomberg is simply reluctant to play ball with any service that could undercut or disintermediate the terminal as the hub for buy-side swaps trading. The company's long-term strategic aim, they say, is to fully control the entire swaps workflow, from executing a trade directly on its Sef – rather than accessing it via an introducing broker – to running the clearing credit check itself against limits hosted by the Sef, to managing the electronic confirms and housing the resulting trade data in its own SDR. The introducing broker model, though new to the OTC market, is standard in futures markets, where companies wishing to access one of the many available trading venues – but that are unwilling to spend the time or money required to connect to them individually – use an account belonging to an existing member, such as a large dealer. An introducing broker must be able to check client credit limits prior to a trade being executed because it stands behind each one. Supporters of this model claim Bloomberg has been slow to make the technology changes needed to facilitate it. "The CFTC's impartial access standards are clear that Sefs must provide open access to all participants, including those wishing to access liquidity through an introducing broker. We have had good success building out the model with many Sefs, but we continue to run into issues with certain platforms. One example is Bloomberg, where it is still not possible for a client to choose the introducing broker model, as the Sef has not built out the infrastructure to support the pre-trade credit check for on-behalf-of trading," says Paul Hamill, head of execution services at UBS in New York. Bloomberg announced its first sponsored access trade back in February, executed by Credit Suisse on behalf of its client, Nisa Investment Advisors, through the firm's Sef. A source close to Bloomberg says it has continued to process this type of trade on a daily basis with Credit Suisse. There are some fundamental differences between the UBS and Credit Suisse offerings, however. In the sponsored access model, clients trade using the membership of Credit Suisse, meaning the bank takes on all membership obligations for clients, such as regulatory enquiries from Bloomberg, plus any reporting or record-keeping requirements. The client is still required to log into a Sef directly, however, and trades under its own legal entity identifier (LEI). In the case of Bloomberg, that means it needs to have access to a terminal. At UBS, the introducing broker model allows clients to have trades executed on Sefs by the dealer, removing the need for a direct connection. So far, UBS has been unable to complete trades on Bloomberg for users of its service, says Hamill. "When the Sef receives an order it needs to run a pre-trade credit check, which requires two pieces of data: an LEI for the customer and an LEI for the customer's futures commission merchant (FCM). It is that combination of data that allows the credit check to happen. Bloomberg is currently unable to run that credit-check process for customers wishing to access the platform via an introducing broker. As it stands, an introducing broker client trade will simply fail. Obviously it's frustrating, and we are in dialogue with Bloomberg and pushing them to prioritise making the fix for our customers," he says. A source within Bloomberg familiar with the issue acknowledges there is a problem with the recognition of LEIs on agency trades, but claims it arises at Traiana's credit-checking hub and not with the messages being sent from Bloomberg Sef. "The credit-checking hub is having issues over whether it can interpret the LEI properly. There is work being done between Bloomberg and Traiana to solve the problem, but it only occurs where an FCM is looking to trade on behalf of a customer and the customer's LEI gets pushed down, and the trade comes through under the FCM's LEI. Bloomberg is working on this with the credit hub and work is required on all sides to fix the issue," the source says. A Traiana spokesperson denies that the credit checking hub has experienced any problems with its third-party clearing credit-checking service, stating that Traiana CreditLink supports agency trading and is currently live with three Sefs for agency workflow. UBS's Hamill says the bank has encountered these problems at some other venues, but other dealers say at least one platform has been able to find a relatively simple fix. "Our agency trades at Tradeweb weren't going through because any trade I entered was automatically recognised as coming from our firm. Tradeweb solved the issue by giving us a new LEI for trades submitted on behalf of clients. It's not the most elegant solution since you have to log out and then log in again under this new ID, but it gets the job done," says a clearing specialist at one US dealer. More broadly, Bloomberg is accused of being slow to facilitate external credit checks of package trades executed on its platform. When the industry was trying to agree a standard approach to providing clearing certainty at the point of execution, a number of models were considered, one of which – known as the push approach – requires FCMs to provide Sefs with a regularly updated credit limit for each client, allowing customers to trade at the venue without the need for any back-and-forth checking. The competing hub model involves limits being hosted at a central facility, with which each Sef and FCM needs to connect. The market currently uses a mix of hub and push approaches, but a source close to one of the two existing hubs says Bloomberg has been dragging its heels when it comes to making the technology fixes required to support its model. In particular, the Sef has not attached unique swap identifiers (USIs) to the individual legs of package trades sent to the hubs for credit checking. "Bloomberg was very reluctant to connect with any outside credit-checking capability, and has prioritised solving problems for clients who put limits on the Bloomberg platform ahead of those using a hub for credit checking, which is the majority of the market. Every other Sef has been able to remedy the credit check for package trades and it's perplexing that Bloomberg is still not able to send through credit checks for the most straightforward packages. It has avoided criticism from clients over this so far because the volume of package trades has been relatively low, but having to reserve more of a credit line increases the risk of trade rejection," the source says. Bloomberg responds that the International Swaps and Derivatives Association is trying to standardise how USIs are put together, and says it will integrate this standard into its third-party credit checks once it has been agreed. Again, it's all about enhancing the value of the terminal, claim Bloomberg's rivals, which makes it hostile to anything that smells even faintly of disintermediation. The question is whether the firm's growing power is a positive or negative thing for the OTC market. For Bloomberg's customers, a single-minded devotion to making the terminal more valuable is unlikely to be seen as a problem. For other firms fighting for the attention of those customers, finding a way to counter the Bloomberg model is the new challenge – and not an easy one. "Opening up its Sef to allow aggregators to post Bloomberg's prices on platforms other than its own, providing interfaces so independent software vendors can perform those activities – these are not high on Bloomberg's list of priorities. When you allow the terminal to be disintermediated by an agency trading model, Bloomberg loses its staying power. That is why it has been reluctant to offer on-behalf-of trading so far. It is not getting around to providing these things in a hurry," says the head of fixed-income e-commerce at one large bank....
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