ASX plus Yieldbroker equals???

It has been widely reported that the ASX will invest $65m in acquiring 49% of Yieldbroker.  For the non-Australia-savvy readership I suggest you consider the ASX as a local incumbent stock exchange and Yieldbroker as a Tradeweb-alike.

Yieldbroker has been in existence for around 15 years and is owned by a consortium of local banks and international firms (see https://www.yieldbroker.com/faqs)

The full ownership list shown at the URL above is ANZ, CBA, Citi, Deutsche Bank, JPMorgan, Macquarie, NAB, RBC, RBS, TD, UBS and Westpac.  

What trades on Yieldbroker? Again, from the URL above:

• Australian and New Zealand government securities
• Australian semi-government securities
• AUD denominated fixed rate corporate securities
• AUD denominated floating rate notes
• AUD denominated supranational, sovereign and agency fixed rate securities
• AUD denominated Treasury notes
• AUD denominated government guaranteed bonds
• AUD Swaps
• AUD Repo
• AUD Bank Bills
• AUS OIS
• AUD FRA

So there is a mixture of different fixed income security types.

According to the CEO at ASX the deal “sees an opportunity for ASX and Yieldbroker to work together to deliver the next generation of Australia’s financial market trading infrastructure.”

Sounds wonderful.  So who is a nay-sayer?

“I think it lessens competition in the bond market. It puts significant control in the hands of ASX and enables ASX to keep prices high” – John Fildes, CEO of Chi-X Australia (chief local competitor to the ASX).

The Australian market place is quite unlike anywhere else I have worked.  The market here can be characterised as a complex bilateral oligopsony.  What does that mean in plain English?  Some basic Economics as a refresher, a primer or to be ignored as appropriate (if you want to avoid this section then look for the heading “Jump ahead to here” below)

If you look at one extreme, imagine an economy where in one particular industry there are a large number of producers of a specific, undifferentiated product and a large number of buyers of the product.  In this case a single producer will not be able to increase prices since doing so will result in their customers buying from another supplier.  This is a simplified textbook explanation of “perfect competition”.

At the other extreme imagine an economy where in one particular industry there is a single producer of a specific product and a large number of buyers of the product.  In this case this single producer will be able to increase prices since customers that require their product will have to either pay more or go without. This is the textbook definition of “monopoly”.

Now, imagine an economy where in one particular industry there are a large number of producers of a specific, undifferentiated product.  But in this case there is a single buyer of the product.  As such a single producer will not be able to increase prices since doing so will result in the single customer buying from another supplier.  Indeed, the single buyer may well drive prices down below the level that would be seen in a “perfect competition” scenario.  This is a simplified textbook explanation of “Monopsony”.

Now imagine an economy where in one particular industry there is a small number of producers of a specific product and a large number of buyers of the product.  In this case this small number of producer may be able to increase prices since customers that require their product will have to either pay more or buy from an alternate supplier.  But if the alternate suppliers can see that one firm has raised prices, they may follow. This is a simplified definition of “oligopoly”.

Now imagine an economy where in one particular industry there is a large number of producers of a specific product and a small number of buyers of the product.  In this case this small number of buyers may be able to reduce prices since producers that wish to sell their product have to either accept lower prices or sell to an alternate buyer.  But if the alternate buyer can see that one firm has reduced the price they will pay, they may follow. This is a simplified definition of “oligopsony”.

A bilateral oligopsony is when you have a combination of an oligopoly and an oligopsony.

Harking back to a more IT friendly construct, let’s construct something like a truth table:

Suppliers	Buyers	Name	Comment
Many	Many	Perfect Competition	No price pressure, just supply and demand
Many	One	Monopsony	Buyer creates downwards price pressure
Many	Few	Oligopsony	Buyers creates downwards price pressure
Few	Many	Oligopoly	Sellers creates upwards price pressure
Few	Few	Bi-lateral oligopsony	A fight!
Few	One	Monopsony/oligopoly	A fight!
One	Many	Monopoly	Seller creates upwards price pressure
One	Few	Monopoly/oligopsony	A fight!
One	One	Bi-lateral monopoly	A fight!

So what’s the relevance here?  The above analysis is incredibly basic and in real-world usage Economists tend to look at a wide range of other tools when looking at market structure.  The old structure-conduct-performance paradigm, through to contestable markets and a game theoretic approach. 

So, in Australia there how can we look at the financial services market place?

In simple terms the buy-side in Australia is huge due to the vast amount of money tied up in superannuation funds (“super”).  The investment managers who invest that money tend to keep the funds invested close to home. 

Jump ahead to here…

The Australian buy-side tend not to use FIX to communicate with local brokers and in many cases use IRESS as a terminal based front end to route orders to brokers.  IRESS acts like a multi-tenant single dealer platform – a buys-side installs an IRESS fat-client software application and the fat-client is configured to communicate with an IRESS datacentre.  Each fat-client, when correctly configured will allow a buy-side to route orders to many sell-side execution desks and venues such as execution algorithms.

The ASX is entirely aware of this, since they own a piece of IRESS.  Yieldbroker acts as multi-broker platform for Fixed Income products as listed above.

This leads to an interesting question.  If there is a near-monopoly supplier of buy-side to sell-side equity order routing and a near-monopoly supplier of a Fixed Income multi-broker platform then how do you create synergies when you are an exchange with an equity piece of both?

Buy-sides in the rest of the world have moved to a multi-asset class trading model based upon an OMS with three components: Trade/Order Management including FIX connectivity, Compliance and What-if modelling.  With that in mind, the model of a closed-garden equity order routing system and a fixed income multi-broker platform does not co-exist gracefully. 

It will be interesting to see how the ASX/Yieldbroker combination manages the following:

• True integration with buy-side workflow rather than re-keying
• Moves to multi-asset class trading (where does Foreign Exchange fit into this model)
• Moves by Australian asset managers to insource dealing and look to global best practise rather than legacy trading models.