Banks are not a bond investor’s best friend. At least according to Ken Grifffin, the founder and CEO of hedge fund Citadel LLC, banks are clearly acting selfishly and only in their own interest as they lobby regulators and politicians to put up barriers to new market-makers in the fixed income sector. In an op-ed in the Wall Street Journal, Griffin argues that banks “have enjoyed a privileged position as intermediaries between buyers and sellers in the fixed-income markets” for some time.
He also says that it is not at all surprising that banks claim that their privileged position must be kept to guarantee liquidity during volatile periods. This, however, Ken Griffin says, is a complete myth propagated by banks to “preserve their competitive moat around what has been a very lucrative business.”
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Ken Griffin on bond market liquidity
As Citadel’s Ken Griffin points out, a debate over the role banks should play as liquidity providers during times of heightened volatility is going on right now, and the discussions surrounds how the new regulations resulting from the 2008 financial crisis may impact the role of the banking sector going forward.
Ken Griffin argues that the current debate is missing recognition of the transformation that has occurred in most fixed-income markets as barriers to entry have given way and new liquidity providers have moved in.
For example, broader access to U.S. Treasury markets has allowed many nonbank broker-dealers to compete with banks as liquidity providers. In fact, nonbank participants account for the majority of trading in on-the-run Treasuries today. The wild volatility seen in the fixed income markets on Oct. 15, 2014, made the value of these new liquidity providers crystal clear , with no mention of Citadel’s role in HFT.
In fact, Bloomberg News notes:
His Citadel LLC returned more than 300 percent in a fund started as a high-frequency strategy in late 2007, according to two people familiar with the Chicago-based money manager. The $830 million pool, which added other strategies in recent years, beat the 44 percent gain of the U.S. stock market in the six years through 2013 as well as Griffin’s two main hedge funds, which together have $8.8 billion in assets and rose 45 percent in the period.
Back to Griffin…
A recent federal Joint Staff Report on the volatility of October 15th highlights that nonbank participants managed to keep tight bid-ask spreads and provided the majority of liquidity during the crunch hours, while the banks widened bid-ask spreads and even completely pulled out of the market in a few cases. The large CME Treasury futures market also maintained tight spreads and firm quotes throughout the volatile trading day.
Ken Griffin also notes that the interest-rate swaps market is evolving rapidly. The 2010 Dodd-Frank law requires swaps to be traded in fair, open markets with access to all. Banks have been arguing since the law was first proposed that these requirements would hurt trading of interest-rate swaps.
It turns out, however, that the swaps market has quickly modernized, and firm pricing is currently available in real-time for institutional investors for the first time ever. Moreover, bid-ask spreads are notably tighter, expensive regulatory documents have been minimized and risk has been slashed. In fact, Ken Griffin says a new nonbank market entrant is nearly always one of the top three liquidity providers on the principal electronic trading venue during high-volatility trading sessions.No doubt, Griffin has the interests of the little guy in mind here..