Monday, July 2, 2012

retail, institutional and ECN conduits (credit bond

For a retail-friendly asset class (such as muni), a sell-side dealer system often designs 3 conduits - retail, institutional and external. That's what I saw in a major bond dealer. Later, we also added joint-venture conduit, and "distributor" conduits such as Fidelity and Charles Schwab.

Conduit concept is fundamental. Quote price, quantity, timing, discount, bid/ask spread control, commission, odd-lot discounts.... are all controlled by a system specifically configured for a single conduit. For each inventory item, the trader needs to set up pricing rules for retail conduit, with all the gory details. Then she repeats the set-up process for institutional conduit. Then external conduit.

External refers to ECNs, often jointly owned by major dealers in the given security.

Retail and institutional are both "internal" conduits owned and operated by "us" the dealer desk. In the context of quote dissemination, we want to put out different bid/ask prices to retail clients vs institutional clients. That's why we have the 2 conduits separated.

In theory, if we had a dominant and special client such as a big online distributor, we could have created a dedicated conduit just for this client. We would publish all quotes to this special client, but with the prices customized.

Institutional clients include investment/commercial banks, pension/mutual funds, insurers, regular corporations... These clients are often on the ECN too. If a given insurer gets the same quote from us on institutional vs external conduits, the prices may differ. On the internal institutional conduit, each client account is carefully managed because we maintain a relationship. So the prices could be better.

Even within the institutional conduit, we may want to give preferential prices to long-term, high-credit investors. High frequency shops will get bad quotes (high bid/ask spread) because they tend to extract money. Tiered pricing is the ultimate quote pricer for such a purpose.

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