It is possible to have two very different, but equally correct, views on the liquidity of the US Treasury market. If you’re trading the most recent issue in a given tenor – the on-the-run bonds – then it’s not hard to find bids and offers in good size. If you’re trading off-the-run, however, it can be a very different story.
When a bond goes off-the-run, transaction costs rise by an average of 40%, the length of time to execute increases by one-third, prices increase by 15% and market depth falls by nearly 37%, according to a Greenwich Associates report released in September.
The causes are well-understood – a layering of new bank regulations that has shut down bank proprietary trading desks and also made it more expensive for dealers to stack their shelves deep and high with bond inventory. The solution is less obvious, but seven-month-old venue OpenDoor Trading – a session-based all-to-all platform – plans to be part of it.
“We were slightly ahead of the curve in understanding the negative impact regulatory reform would have on primary dealer balance sheets,” says Susan Estes, the firm’s co-founder and chief executive. “Since the early 2000s, thought leaders talked about the need for all-to-all fixed-income platforms, but it was regulatory reform that provided the catalyst to deliver this change in market structure.”
The platform was designed to promote transparency and liquidity. It does so by bringing participants together for three anonymous all-to-all matching sessions, known as ‘auctions’, each day. In these sessions, all participants are treated equally – dealers, central banks, pension funds, hedge funds and sovereign wealth funds.
Every auction consists of three distinct phases: the pricing phase, the breathing phase and the matching phase. During the pricing phase, OpenDoor combines price contributions from dealers with data from external and internal sources to come up with indicative prices for a list of securities. In the ensuing breathing phase, orders are submitted anonymously by participants that want to buy or sell those securities. While there is no obligation to use the indicative price, nearly 70% of orders are posted at the indicative price. Once the breathing phase is over, the matching engine is turned on for 10 minutes and buy and sell orders are matched at the best available prices.
While a traditional request-for-quote platform would require buy-side firms to show their hand, and may not always lead to the best outcomes if dealers are not willing to take the other side of the trade, the auction model allows complete anonymity and offers the potential to bring the best available liquidity together in one place. The idea is to encourage participants to place their full size into the auction and show their best price.
With the very first trade, in the first auction, OpenDoor successfully transitioned a portion of the US Treasury market to a riskless principal, exchange-like model where the primary dealer is not the designated market-maker, but rather another platform participant with separate responsibility to facilitate the clearing of customer tradesSusan Estes, OpenDoor Trading
Since the launch of the platform, roughly 13% of traded orders on OpenDoor have been matched at better levels than the order price, satisfying regulatory requirements for best execution.
OpenDoor has signed up eight primary dealer ‘sponsor’ members that clear and settle the trades that are matched during the auctions, but they have no other special status – if they also use the platform to trade for their own account, they use the same protocols as everyone else, and they have no visibility into other users’ order books during the auction. More than 35 buy-side firms currently participate in the platform.
In all, OpenDoor has hosted more than $200 billion in orders since its launch, with matched trade volume of more than $7 billion. This is still small beer compared with Treasury volumes on other platforms, but users see it as a promising start.
“OpenDoor has made a lot of headway in a short period of time in an area of the fixed-income market that did not previously have this kind of platform. We can trade off-the-run Treasury bonds with dealers through other channels, but this is an effort to bring additional liquidity to the market in a different format,” says a portfolio manager at a US state pension fund.
With a 25-strong workforce, OpenDoor has declined to accept market participants as stakeholders, to maintain independence, but it has successfully secured the backing of private investors. Following an initial $2 million funding round in December 2015, the company raised $10 million in July 2016 and a further $10 million in June 2017. It’s not making money yet, but Estes expects that to come next year.
“OpenDoor is a market-based solution,” she says. “We started with the idea that the platform should be both inclusive and anonymous. With the very first trade, in the first auction, OpenDoor successfully transitioned a portion of the US Treasury market to a riskless principal, exchange-like model where the primary dealer is not the designated market-maker, but rather another platform participant with separate responsibility to facilitate the clearing of customer trades.”
With a client base consisting of dealers, central banks, pension funds, hedge funds and sovereign wealth funds, OpenDoor is now looking to onboard more asset managers. It recently partnered with Charles River Development, a provider of buy-side order management systems, to enable direct access to the platform through the vendor’s system, as it seeks to become the market standard for matching off-the-run Treasuries.
“Trading on OpenDoor yields beneficial pricing for all participants. Buy side can match with buy side or sell side, and sell side can match with sell side or buy side. This is the first significant change in the trading structure for US Treasury securities since the primary dealership infrastructure was revised in the 1960s,” says Estes.