Citi, other banks set to ink ‘Octopus’ deal for new multi-bank CLO platform

A consortium of banks is preparing to combine the collateralized loan obligation (CLO) trading efforts of its members into a new multi-bank trading platform, with the working title Project Octopus, WatersTechnology has learned. Sources say the move is a bid to prevent existing fixed-income platforms from cornering the nascent electronic CLO market and charging what the banks see as high fees for trading and market data.

WatersTechnology understands that the consortium plans to set up an independent company with staff and management that will operate a multi-dealer platform to consolidate CLO trading of the banks involved, avoiding a “middleman” platform that would disintermediate their relationships with their buy-side clients and leave the banks subject to whatever fees the platform might charge.

“Electronic trading in the CLO and loan market is still nascent, but given the current search for yield, the surge in electronic trading in fixed-income markets broadly, and technology already starting to take hold in these markets, these suggest that change is coming,” says Kevin McPartland, head of market structure and technology research at Greenwich Associates. “While it’s far from a guarantee, some of the biggest success stories in fixed income have come from consortiums—MarketAxess and Tradeweb, to name only two.”

However, successful initiatives that began as bank-backed consortiums aren’t always seen as being successes for the banks once those initial participants liquidate their investments and move from being shareholders to customers. To be successful in terms of generating revenues and profits, these platforms charge transaction fees, as well as fees to subscribe to the market data generated from those transactions, which represents the benchmark price for those fixed income asset classes.

It’s a bunch of banks who are very big in the CLO loans space, who—rather than let that market go to platforms like a MarketAxess or Tradeweb, as other asset classes have—decided to create their own consortium

Source with knowledge of the project

“It’s a bunch of banks who are very big in the CLO loans space, who—rather than let that market go to platforms like a MarketAxess or Tradeweb, as other asset classes have—decided to create their own consortium,” says one source familiar with the project. The source adds that the banks are unhappy about the fees charged by those trading platforms for participation in other asset classes, and about being disintermediated from buy-side clients by the platforms. “They want to have a consortium that is fair and—though they won’t say it out loud—is controlled by them. They don’t want the genie out of the bottle again.”

Tradeweb and MarketAxess were founded in 1997 and 2000, respectively, with support from major bond-trading banks. However, the banks ceded their investments. Thomson Corp. bought Tradeweb in 2004, then sold stakes to 10 major dealers in 2008. Tradeweb went public in 2019. MarketAxess went public in 2004.

Project Octopus is understood to have originated with Citi and Bank of America, which have since approached five other banks with large footprints in CLO trading. While the participation of those other, unnamed banks is not confirmed, if Octopus enlists only three out of the five it will command a 50% share of the CLO market, the source says.

The initiative started life as an internal project within Citi, which enlisted low-code software provider Genesis Global to build a multi-dealer platform that could support broad industry participation. This platform is currently undergoing testing, and the banks plan to unveil the initiative imminently, sources say.

Genesis declined to comment. Citi and Bank of America did not respond to requests for comment.

Citi made a strategic investment last year—an undisclosed sum—in Genesis “to accelerate Citi’s digitization journey,” said Nikhil Joshi, managing director, global head of spread products technology and head of markets technology for North America at Citi, in a Genesis press release. A further $45 million Series B funding round completed last month also included Citi, as well as existing investors Illuminate Financial and Tribeca Early Stage Partners, and was led by new investors Accel GV and Salesforce Ventures.

Citi already operated a successful CLO trading and analytics platform, Citi Velocity, while Bank of America launched its Instinct platform for electronic trading of syndicated loans in 2016, and the other banks involved also have their own single-dealer CLO platforms, according to sources. But a crucial part of the Octopus agreement is that the banks involved plan to switch off their proprietary platforms and migrate all CLO trade flow to Octopus.

“That means this will immediately have critical mass,” which—along with technology—has been a gating factor for consortium-led initiatives in the past, the source says. “The unique thing is they’ve already built the technology, whereas in the case of many other consortiums, they never get their shit together in terms of technology. That’s not the case here.”

This kind of data is not difficult to transport, and could be delivered via any channel—over the cloud, through a portal, or on-screen. The question is whether it will package and distribute it to aggregators, or only make the data available via its own platform.

Data executive

In addition to mitigating the impact of trading fees for participants, Octopus also plans to create a revenue line from selling its market data, which—while perhaps not high-volume—based on its participants would effectively be the benchmark dataset for the CLO market.

“These structured deals are not going to throw off a ton of data to start with, so any data may be more referential at the start—it certainly won’t be real-time streaming data,” says one experienced data industry executive, who suggests that capturing and distributing its data would not be a burdensome component of Octopus’ plans. “This kind of data is not difficult to transport, and could be delivered via any channel—over the cloud, through a portal, or on-screen. The question is whether it will package and distribute it to aggregators, or only make the data available via its own platform.”

The other question, this data executive says, is whether the platform will only ever trade CLOs, or whether the banks will use it “to dip their toe in the water” of electronifying other asset classes. Or even, once it has critical mass in one area—to encroach on other asset classes already traded via other platforms, such as treasuries, eurobonds, currencies, rates, and futures. “Then you’d be talking about ‘real’ data that [by cutting out the middleman and their fees] could really impact your bottom line in terms of costs,” the executive says.

Once Octopus creates the independent entity that will run the platform, it will hire management and staff. While not naming any of the others potentially involved, the source says they will be experienced executives with “battle scars” and the knowledge to prevent mistakes that may have hampered similar efforts in the past.

CLO market ‘ripe’ for change

Tradeweb confirms that it does not currently trade CLOs, but declined to comment on the new initiative, or on whether it has any plans to introduce CLO trading on its platform.

MarketAxess, which has offered electronic trading of leveraged loans since 2016, says it welcomes the competition—especially if Octopus plans to facilitate trading of CLO tranches as well as (or instead of) the underlying loans—because it will increase transparency in a market that is opaque and illiquid but has great growth potential.

Howard Cohen, head of leveraged loans at MarketAxess, who joined the platform last year after almost 14 years as a loan portfolio manager at Morgan Stanley, says he sees growing demand from CLO clients for MarketAxess to introduce trading in CLO tranches. He says the platform is looking at adding this, though probably not this year.

Cohen says CLOs represent “fantastic growth potential,” and are in a virtuous cycle this year driven by rising interest rates, increased exchange-traded fund inflows, and higher issuance levels. “There is more product to trade and more customers. So the runway for this product is in really good shape,” he says.

S&P Global Market Intelligence is also predicting a bumper year for CLOs after a contraction in 2020 marked by volatility, loan downgrades, and higher defaults, leading to lower issuance. Overall, between 2008 and the third quarter of 2020, the outstanding balance of CLOs more than doubled to $845 billion.

The loan market is ripe for electronification. I liken it to the bond markets 20 years ago before Tradeweb and MarketAxess

Howard Cohen, MarketAxess

However, Cohen warns that the market still suffers from a lack of transparency, liquidity, and any Trace-style tape as exists in the bond markets.

“The loan market is ripe for electronification. I liken it to the bond markets 20 years ago before Tradeweb and MarketAxess,” Cohen says. “The juggernaut we’ve built on the bonds side has brought benefits in terms of transparency, liquidity, and information that people would also like to see us bring to the loans space. So we want to jump on that, and probably that’s why the dealers want to, as well.”

He says that while Octopus may be a move by the dealers to “protect their turf,” it nevertheless should promote competition and benefit customers.

“We’re the only electronic loan trading platform on the planet where the buy side can access liquidity from multiple dealers. Now, that’s a good and a bad thing, because the buy side may want more than just one choice. So I think a couple more venues is a good thing so that the buy side can have some comparison,” Cohen says. “If this provides liquidity in tranches and underlying loans, it’s a step forward. And to the extent that this will provide competition and liquidity, that’s only a good thing.”