The Value of Marketplaces in Hedging
Would you buy an airline ticket for personal travel without checking prices across airlines? A hotel? A rental car? Would buy a share of stock from an acquaintance without checking the current market price? Would you buy a car at the first dealer you visited without comparing pricing?
Probably not – especially in a time when information is available in real-time with a few simple clicks.
Marketplaces work. They bring buyers and sellers together at the same time for the same product with the same information – resulting in real-time price discovery and efficient execution.
Hedging should be no different. In order to conduct true price discovery, hedgers and their financial counterparties ("Dealers") must be looking at the same product – with the same structure, volume, and tenor – at the same time. Markets are constantly moving and “current price” matters.
1. With no competitors in play, the Dealer does not have to provide a “best” quote – only a quote that is “good enough” to prevent you from moving to the next Dealer;
2. Any Dealer that bids but is not selected can potentially use the trade information to the hedger’s detriment in the open market;
3. Even though markets are constantly moving, a Dealer – once eliminated - is not afforded the opportunity to adjust its quote to reflect current market conditions;
4. Some Dealers will be unnecessarily excluded from trades when terms are agreed upon before those Dealers are even aware of the trade; and
5. Most importantly, it is not possible to make an “apples to apples” comparison when each quote reflects different market conditions.
In short, a hedger cannot possibly know if the “best price” was achieved when executing serially. The same is true when multiple quotes are being collected by phone since, by definition, these quotes do not reflect concurrent market conditions.
1. Issues hedge details to all Dealers at the same time – avoiding potential front-running;
2. Uses a set of rules and processes to ensure Dealer is treated fairly and consistently;
3. Collects real-time quotes in a central location to enable meaningful quote comparison;
4. Allows each Dealer to adjust its quote as the market changes;
5. Permits the hedger to select any quote for any reason at any time (even if not best price); and
6. Automates all downstream trade capture, confirmation, and reporting; and
7. And if a hedger prefers serial execution for some reason... marketplaces can do that too.
Importantly, hedgers executing through CFTC-approved marketplaces can rest easy knowing i) they saw the best available price, and ii) that the transaction was compliant.