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I’m reading a whitepaper on OTC markets from the interdealer broker ICAP… lots to comment upon…

ICAP is the world’s largest and most powerful broker’s broker… headquartered in London they deal in FX, fixed income, derivative, commodity, and money markets. Their operations span all currencies and timezones.

ICAP serves as the central hub for massive global flows of financial assets. . . approximately $1.5 trillion per day. . . ICAP itself is the ultimate OTC market… it floats serenely at the top of the global financial food chain…

ICAP’s greatest strength is the global financial systems weakest link…

The dealing network that ICAP supports is a closed information loop…

ICAP’s clients are all dealers themselves… these dealers have thousands of clients with whom they trade…  the trade data generated by dealers trading between themselves through ICAP is never downstreamed to the thousands of other market participants… ICAP functions as a cartel within the broader financial markets… 

~~~~ ” …. A cartel is a formal (explicit) agreement among firms. Cartels usually occur in an oligopolistic industry, where there is a small number of sellers and usually involve homogeneous products… The aim of such collusion is to increase individual member’s profits by reducing competition…” ~~~~

Is there anything in the law that would prevent dealers from excluding others from participating in these dealing arrangements? I don’t know… something to think about… but on a common sense level “tiered markets” disadvantage other market participants…

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I wrote about tiered fixed income markets and how they damage retail investors in particular in recent comments to the SEC (page 4) …

~~~~ ” … Rule 3a1-1 provides quantitative thresholds for the determination of “substantial market” for a “trading system” being exempt from registering as an exchange…

We propose that the Commission review this exemption and its application with a more realistic approach that incorporates the stratified structure of the fixed income markets.

The market stratification is clearest when one examines the access available to various market participants to electronic trading platforms.

E-platforms are clustered into various client and product types. These are further grouped by type of access:

• Dealer to dealer (interdealer platforms)

• Single dealer to institutional clients

• Multi-dealer to institutional clients

• Single dealer to retail clients

• Multi-dealer to retail clients

SIFMA conducts an excellent annual survey of fixed income electronic trading platforms. This is a useful reference for preliminary mapping of these markets.

We encourage the Commission to review the quantitative application of Rule 3a1-1 within these more narrowly defined market segments. We believe that this review will show excessive market concentration.

And on the basis of this review we believe it would be appropriate for the Commission to require various electronic fixed income trading systems to register as exchanges and/or to create linkages to each other which would mirror the principles in the “Access Rule” (Rule 610) in Reg NMS.

The Commission adopted these Reg ATS rules to regulate “substantial markets”. This was necessary and appropriate in the public interest and consistent with the protection of investors….” ~~~

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ICAP has made some good suggestions related to trade execution and settlement issues —

• Wider adoption of electronic trading – Electronic trading creates greater price transparency, enables simpler and faster trade capture, affirmation and confirmation and easier supervision of trading activity.

• Quicker settlement cycles in all securities markets – A T+1 settlement cycle for all securities markets should be mandated.

• Faster and automated affirmation/confirmation of all derivatives trades – The affirmation and confirmation of all OTC trades in all markets needs to be automated and accelerated as close as possible to the trade date.

• Greater use of pre-booking netting – In many cases, transactions can legally and economically be netted, rather than settled on a gross basis.

• Wider adoption of central counterparty (CCP) give up and/or central clearing for OTC derivative markets – Those markets that do not already operate a central counterparty should introduce a CCP/clearing house that is independent of the trading platforms for those markets.

• Wider adoption of portfolio reconciliation – More regular and comprehensive reconciliation of OTC trade details and valuations between counterparties should be mandated.

• Wider adoption of portfolio compression in derivatives markets – More regular and comprehensive compression of derivative portfolios, ideally on a multi-lateral basis.

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From FT.com: