Interdealer broker of the year: BGC Partners

It’s not delivered as a rant – the banker speaks slowly, his voice is even – but it looks like one when written down.

He is talking about the changes he’s seen in the way interdealer brokers operate. Or, to be more precise, the changes he hasn’t seen.

“All the major traders still have open lines to a range of brokers who they talk to through the day, and they transact a decent amount of business through voice execution. That’s exactly as it was when I first started trading 25 years ago, and it’s pretty surprising,” he says.

“There are pressures for this to change. One is obviously cost – banks pay a very significant amount of money in commissions to brokers – and the other is electronification. I don’t think those pressures are going away, I think they’re going to intensify, so brokers will need to reinvent themselves. The voice component is inevitably going to shrink as a share of the business. It’s just taking longer than most people will have anticipated.”

He’s not alone in those sentiments. A second senior trader talks of his “frustration” at the lack of evolution in broking; a third says greater use of electronic and hybrid trading models is “the key change that needs to come to this market”.

All brokers have heard this message. At BGC Partners, Shaun Lynn is broadcasting it from the president’s office, to a front-office workforce of 2,940 – many of them voice brokers whose natural inclination might be to fear change.

“This is a time to embrace technology, not to run away from it. It will make you more effective in your job, more compliant, more global and you will be able to offer cheaper execution to your clients,” he says.

But there is a balance to be struck. “Technology costs a lot of money, and it takes a while to pay a dividend,” Lynn notes.

BGC Partners wins Risk.net’s inaugural Interdealer broker award for the way it has struck that balance over the past 12 months. On the one hand, the firm has played to its traditional strengths, adding at least a dozen senior hires from places like Bank of America, HSBC, Icap and JP Morgan, and continuing to grow its traditional broking business – as of the end of 2018, the firm’s revenues were up 25% to $1.9 billion over a three-year period, and its first-half revenues this year were just shy of those at TP Icap, still the largest of the big three brokers in revenue terms.

On the other hand, it has been laying the foundations for a different model. That means repositioning Fenics – originally a foreign exchange software provider – as a kind of incubator and advocate for all of BGC’s electronic and data initiatives. It also means the launch of platforms with all-new trading protocols based on painstaking research, such as Fenics Global Options for listed equity options Delta X in credit markets.

This is a time to embrace technology, not to run away from it

Shaun Lynn, BGC Partners

And it means not kidding itself. Where other brokers might define an electronic trade as anything that is displayed on a screen for some portion of its life, BGC only counts transactions executed without any voice component, says Dean Berry, a Deutsche Bank and Icap alumnus who joined BGC as its global head of electronic and hybrid markets in 2017.

That strict definition gives the firm something real to measure: “Every day, I receive stats on the percentage of electronic business completed by each of our more-than-400 desks. And it’s growing more rapidly – over the last three months, the total share of electronic was up 12% quarter-on-quarter,” says Berry.

Investors might be interested in that figure. Berry notes that publicly listed operators of electronic trading platforms enjoy far higher earnings multiples than brokers – so, if BGC can complete a greater share of its business via screens and machines, then it won’t just be keeping its traditional clients happy: “Every dollar of voice revenue that we move to electronic drives the share price,” he says.

Delta X is supposed to speed that up. The platform took more than a year to build, with clients being canvassed for advice and ideas early in 2019, according to one senior credit trader. He says the result is “far more innovative” than other broker-run ventures; a second credit trader describes it as “relatively unique” in the broker market.

One of its big innovations is to essentially invert the usual trading protocol used by interdealer brokers – the volume-matching system whereby a broker desk will set a mid-price for a particular instrument and then invite traders to participate, with buyers and sellers being paired off when their bids and offers align. On Delta X, participants upload their inventory to the system first, creating a rich, centralised database that a machine learning algorithm then combs for potential matches. Trading sessions are still run regularly throughout the day, but now traders are only invited to join in if they have an interest.

“Traditional hit rates are around 10%, but we’ve seen hit rates increase dramatically in the soft launch phase for Delta X,” says Berry. “That’s because we’re only alerting people to a session if we know they care; and, if you care, then you will price more keenly and respond more quickly.”

A second innovation is the creation of what Berry calls ‘private negotiation’ where participants can trade outside of the regular sessions. Working through the platform’s pooled data, the Delta X algorithm will invite two or more firms into a negotiation when it finds opposing interests – buyers know they are being connected to potential sellers, and vice versa, but neither side knows how many participants are involved.

It’s a way to address the winner’s curse associated with the request-for-quote protocol that is common in less-liquid markets: the winning quote gets the trade, but now all of the other participants have the information that a trade was done, and can adjust their pricing, making it harder for the winner to hedge. The result is that RFQ participants may not price as keenly as they otherwise would.

“In this new protocol, there could be four trying to buy and one trying to sell, or three versus two, and so on,” Berry says. “But if you don’t know who is trying to buy, and how many, then it could just be you. And if you don’t get the trade, you don’t know if anyone else did either. It creates much better competition within the room, and we’ve found it to be really popular.”

Clients who have been involved in testing the platform back that up.

“What they’re trying to do is maintain the integrity of voice broking – so, a private negotiation without too much info leakage – while still allowing it to be dynamic electronically, meaning you can enter a ton of information in one go,” says the first credit trader. He estimates that around 30% of his broker trades are currently done via voice, with the rest matched electronically: “There’s no reason these guys couldn’t capture a significant share in both.”

We’ve benefited from this year’s increase in rates volatility and volumes, and those macro conditions have lent themselves to changes we’ve made

Anthony Warner, BGC

It’s too early to talk volumes – the platform was in soft-launch mode during September and October, and is now being rolled out more widely – but BGC’s Lynn describes its scope as “almost limitless”. Although it currently serves only the credit market, Lynn says the new protocols could be applied more widely: “It definitely works for credit, definitely works for rates. But there’s a need for it in almost every market of ours.”  

While Delta X and other electronic platforms try to establish themselves, BGC’s revenues will continue to be heavily reliant on voice broking.

Anthony Warner, general manager for BGC Brokers’ Europe, Middle East and Africa business, runs the firm’s biggest brokerage office and is – like Berry – one of the executive managing directors that report to Lynn. He chalks up the firm’s strong first-half performance – it booked just over $1 billion in revenue, up 8% on last year – to an across-the-board increase in volatility, but also to tactical changes within BGC. For example, the decision to beef up the firm’s focus on short-term rates, with Kieran Davis joining from Barclays to co-lead a new 11-person team.

“We’ve benefited from this year’s increase in rates volatility and volumes, and those macro conditions have lent themselves to changes we’ve made – focusing more on rates and foreign exchange products, for example, has really paid off because it helped us capture those movements,” says Warner.  

So, how do Warner’s staff feel about the electronic strategy?

“I can’t think of areas where we’ve reduced headcount in brokers because of the transition to e-platforms,” he says.

And he adds that the firm as a whole is starting to think of itself in a very different light. Warner may have spent 24 years at Icap before joining BGC in 2015, but he doesn’t name TP Icap when asked who his current employer’s biggest rivals are – he picks out electronic venues like Tradeweb as the threat.

“When we sit down on Monday mornings and talk about how to play out the next week, the next month, the next six months, we’re looking at the bigger threats from those venues, rather than wondering how we can drag market share from the other brokers. We don’t want to win the battle and lose the war,” he says.

It’s the same message from Lynn and Berry. While platforms such as Bloomberg, MarketAxess and Tradeweb may be seen as dealer-to-client venues – serving the other half of traditionally bifurcated fixed income trading – their model is evolving. Tradeweb offers an interdealer platform, Dealerweb; MarketAxess completed its acquisition of US Treasuries streaming service LiquidityEdge last month. And even though the platforms are typically seen as dealer-to-client, their main liquidity pools are all-to-all – meaning banks can trade with other banks.

For Lynn, this is part of a general blurring of business mixes and models among brokers, exchanges and multilateral venues – a trend that is already shaping BGC’s strategy, and will continue to do so for years to come.

“As much as I respect my traditional competitors, I don’t look at them as my future competition. My future competitors are Tradeweb and Dealerweb, Bloomberg, Refinitiv. Ice has execution services, CME owns Nex and therefore Brokertec so it has US Treasuries execution. Those lines have blurred and we’ve moved along with it as well – we offer compression and other post-trade services. The execution landscape is changing, and we’ve had to listen to our clients in order to stay competitive,” he says.