The Big Interview: Susan Estes

OpenDoor Trading’s CEO, president and co-founder, Susan Estes, discusses the future of fixed income trading and how disparities in US Treasuries trading have affected the buy-side.

Hayley McDowell: What does the US Treasuries landscape look like at the moment?

Susan Estes: It’s becoming more interesting. We are on the other side of artificially pegged low rates in the US, so in October, the Fed began to allow its SOMA portfolio holdings in Treasuries and mortgages to roll off, and the pace will increase. As far as market structure is concerned, the bifurcation between on-the-run and off-the-run Treasuries remain pronounced, but the extent to which it has a market impact is less clear-cut.

Those arguing that the Treasury market is functioning perfectly well are speaking from their experience. But so are the others, arguing the other side of the coin. It is completely dependent upon the seat you are sitting in. For the biggest firm, trading Treasuries is not a pain point. The symbiotic relationships they have with the top tier dealers is mutually beneficial and self-reinforcing.  As thought leaders in the industry, their experience becomes the accepted norm. But hold on.

When you speak to the second and third-tier players, some with substantial AUM, but less turnover and therefore less value to the top-tier sell-side firms, the experience is quite different. The false sense of comfort that all is well across the markets, because all is well among the top-tier, is concerning. We have been, and we remain in a low volatility environment, and that can mask a lot of things that have the potential to derail market participants if that were to change. The US Treasury market is at $14.3 trillion and growing. I am uncertain we have the right mechanisms in place to absorb even a small re-allocation — in percentage terms — out of US Treasuries over a short time period without some negative consequences. After all, just a 1% shift in allocation amounts to around $140 billion, and we need to think about what that means for the market.

The top five dealers have the capacity to facilitate liquidity for the top tier asset managers. They could certainly stand in initially, but what would a 3% move do to their capacity to transfer risk if it occurred over a few days. How about 5%? The present positive reinforcement cycle has buried discussions of concentration risk, but it is naïve to think that at some point it won’t be challenged.

Discussions about what impact $140 billion times three or five will have on the market is not presently on anyone’s radar. However, we started thinking about this when we founded OpenDoor three and a half years ago. The idea that 98.5% of the market wasn’t really trading with any level of fluidity, and the difficulty in getting a price on some of the deep off-the-runs was very concerning. A simplistic, but reliable way to understand what the market is capable of is to follow the money. Just because holders of these securities have not been actively trading them, does not mean they won’t. And to consider what will happen if they do is simply prudent risk management.

HM: Why did you launch OpenDoor when you did?

When we founded OpenDoor, we thought it likely that we would have time to engineer something that would allow disparate sources of liquidity to find one another before the Fed began to taper. We were also hopeful we would have the time to perfect the protocols before volatility increased. Having launched in April last year, and having just rolled out a significant upgrade, we are now grateful we not only had the time, but also the support of our core group of first movers.

I think the concern this initial core group shared, that the combination of concentration risk and complacency was too high to be sustainable over the long run and maintain a healthy market, is now resonating with others. The number of accounts adopting the platform is accelerating. The total AUM of buy-side participants is up 84% over the last eight months and the distribution is broad-based, split among pension funds, insurance companies, asset managers, sovereign wealth funds, central banks and others. This ongoing adoption tells us we are getting something right and that others share our initial concerns for the need for alternatives to existing liquidity solutions.

HM: How does the buy-side perceive off-the-run Treasuries in the current environment? 

SE: The perception of off-the-run Treasuries is directly tied to the size/importance of the buy-side participant and the collective experience of their peers. Broader acceptance of the idea that the Treasury market is bifurcated between OTRs and OFTRs began in earnest in late 2015 and early 2016. I think that now there is, at a minimum, a reasonable understanding among most participants that the two areas of the market are separate and distinct. We need to begin to shift the dialogue to the experience and division that exists among classifications or tiers of participants. Some market players are more educated on this than others, but I believe it is very important to get the industry thought leaders to look beyond their own experiences.

The idea that the market has the potential to be volatile is accepted, but there is a complacency around the reality that we can’t always predict when. There are asset managers who drove the conversation about the need for all-to-all venues and the need to improve TCA who are now concerned about the collapse of bid-offer spread because in this low volatility environment they pick up alpha by standing in and buying behind the bid or selling above the offer when dealers are offsetting unwanted positions. That may be a great strategy if you are confident you can call the turn. If not, it is a little like picking up pennies in front of a bulldozer.

The ability to buy or sell large blocks of securities at or through the indicative mid, without disclosing size and in full anonymity should be the end-game. That is what we are building tools to do. The bigger picture should not be the worry about spread compression and giving up the smaller edge, but rather the focus on how significant blocks will be moved when investors start shifting out of Treasuries.

HM: What do you believe will shape the future of fixed income trading?

SE: The buy-side will continue to have a larger voice, and relationships will always matter. Dealers are important to the buy-side and we need to recognise the value they have in the overall marketplace. One of the things we did at OpenDoor was leverage a riskless principal model specifically designed to preserve and enhance the dealer relationships with our shared client base. Dealers get paid for their infrastructure without having to take risk. Is our model the future of the market? I don’t think any one model will prevail, but we are positioned to be part of the solution.

HM: How do you see OpenDoor positioned in the market a few years from now?

SE: I would like to see us fully integrated into everyone’s workflow and evolve to a place where certain dealers stop viewing us as a threat. Some of the larger dealers have held back and are not participating because they are facilitating the majority of transactions in OFTRs for the top-tier accounts. That’s a massive revenue flow, and the revenue we offer as a percentage of what is charged to the end user, does not come close to off-setting the revenue they presently capture on an OFTR transaction.

It’s interesting because we have the buy-side telling us they get good prices all the time and indicate our transaction costs do not stand up to the execution they get away. But if that were the case, and if we can’t begin to cover what the dealers are making on the bid-offer, the argument cannot hold. It is important for market participants to understand that we want to enhance the dealer’s workflow, not detract from it.  Twelve percent of our matched trades are filled at better levels than the customer was trying to execute. That is alpha. That has remained consistent even as our matched volumes have continued to increase.

I think it is imperative we keep perfecting the tools we have introduced for Treasury Inflation-Protected Securities and OFTR Treasuries. If we get that right for our end users, if we understand their pain points and incorporate solutions that help them improve their performance, everything else will follow.