Second in a series of interviews with technology leaders whose views are relevant to AMG members.

Interview with Kelley Millet, President, MarketAxess

Asset Management Group: What are the main focus areas for MarketAxess heading into the New Year?

Kelley Millet: While the traditional request for quotes in high grade is our largest and most mature business, it continues to be one of our main focus areas for 2007. It's an area in the market with the least margin for the dealer community and the greatest need for efficiency among the buy side in terms of the size of the flow, and we think there's great potential in this space.

If you examine TRACE data, which is something we do with BondTicker on a real-time basis, the question remains, "What measure of that TRACE data could be considered lower margin flow?" As a dealer, you need to meet the demands of your buy-side clients, but chances are you're not going to make an awful lot of money, if not losing money on a traditional bid/offer basis. So MarketAxess has looked at everything less than three years in maturity, less than $5 million in size and all FRNs in order to define it differently. Some dealers think that's sensible and others do it slightly differently, but this makes up roughly 57%-58% of TRACE in volume and probably north of 95% in terms of tickets.

We estimate our share of this flow business is currently somewhere in the mid-teens. Given the potential for up to 58% of this volume to go electronic, we feel well-positioned to provide the means by which the buy side and sell side can execute this business in a more efficient manner.

The second focus area for MarketAxess in the year ahead is the inter-dealer business, which we operate under DealerAxess. That model is dealer to dealer versus client to multi-dealer, and we see a couple of very distinct advantages there for us. One, we offer significant cost savings in terms of our pricing schedule versus the traditional voice broker --it's probably on average roughly 35%-50% less expensive to execute a trade on our electronic platform than in the traditional voice marketplace.

Second, there is also a distinct compliance advantage thanks to the electronic audit and compliance trail.

Asset Management Group: MarketAxess recently released some interesting monthly volume data. Can you discuss those numbers?

Kelley Millet: Our recently released totals for December show that volumes were $27.5 billion for the month and MarketAxess had a 10.7% estimated market share of U.S. high grade, which is a monthly record for us. I'm careful not to get too excited based on month to month results, but the quarterly and annual trends all seem to be moving in the right direction for us, and reflect a number of drivers of adoption. First, the buy side is under increasing pressure to achieve best execution. Second, e-trading solutions can address challenges faced by both the buy and sell side to manage compliance risk. Third, the efficiencies achieved by connectivity and automation will accelerate migration to e-trading. Finally, from the dealer-perspective, the pressure on client flow profitability can be effectively addressed by e-trading.

Asset Management Group: What is happening now in the rest of the marketplace?

Kelley Millet: From the buy-side's perspective, there are several important issues. The need to be able to demonstrate the best quality of execution in this marketplace can be addressed by an electronic method of capturing a high quality audit trail. At MarketAxess, we provide the buy side, through our data products, highly effective and customizable compliance tools.

While there are significant drivers of market adoption, at the end of the day, both the buy and sell sides have some uniqueness in their business models. We're trying to understand that and deliver technology solutions to ultimately deliver the liquidity pool that fits with what they're trying to achieve.

Asset Management Group: What's the outlook for Credit Default Swaps?

Kelley Millet: The CDS business has grown exponentially and there is no TRACE equivalent. On the buy-side, that business has traditionally been dominated by leveraged funds, but we're in for a change. Our focus in the first part of 2007 is on single-name lists and executing on behalf of our buy and sell side clients. We have four major software enhancements that we will roll out in 2007 and we're extraordinarily focused in building a highly efficient tool for them to execute single-name lists.

We are encouraged about the progress we've made, working in partnership with dealers and leveraged funds, and we're looking forward to seeing some fairly significant growth in single-name lists as early as the first quarter of 2007.

Asset Management Group: Regarding the convergence of the derivatives markets and fixed income markets, do you find that MarketAxess has clients — especially buy-side clients who are traders or trader/portfolio managers — who are simultaneously using your services to affect trades in both the CDS and high-grade or high yield markets?

Kelley Millet: They are currently the exception rather than the rule. From a buy side perspective, the dominant traders in CDS are hedge funds and leveraged funds and the correlation desks. They trade very little cash for two reasons. First, derivatives are obviously much more efficient from a balance sheet standpoint — they're highly leveraged and extremely efficient. Second, there hasn't been the liquidity or the volatility, i.e., the risk/return in cash that would merit getting involved there.

Nevertheless, both the CDS-dominant trader and cash-dominant trader know where the market is in the other securities because in certain instances, CDS is driving the cash price, while in others, cash can affect CDS. CDS business being traded electronically in the U.S. is still in its infancy, so the simultaneous use of cash in CDS is not currently prevalent in the marketplace.

Asset Management Group: Regarding the delivery of data that you maintain as a vendor, what are the latest innovations being developed by MarketAxess that are designed to serve the needs of the securities dealers and investment management firms?

Kelley Millet: We are rolling out a compliance suite of products for the buy side, and the response to date has been positive. These products will enable buy side users to aggregate trading information and formulate the kind of report that is necessary for either their management team or board.

Data services, especially as it relates to compliance, goes hand-in-hand with the execution of our business model in the electronic trading space. As more of the business becomes electronic, especially in the lower margin commoditized business, the ability to make it more efficient from a compliance standpoint serves the needs of the buy side to a much greater extent.

In addition, during 2006, the buy side focused on straight-through processing with almost missionary zeal. As we enter 2007, the number of MarketAxess client STP connnections has jumped from around the mid-40s to now in excess of 100. We're extraordinarily focused on delivering STP solutions to our client base. And obviously the flipside of that on the sell side is dealer APIs, in order for them to be more responsive and more efficient to inquiry.

Asset Management Group: In today's marketplace, who should bear the cost of implementing electronic trading systems?

Kelley Millet: I have an overriding concern each day about how we can add value to both our investor clients and our dealers, i.e., our customers. Ultimately what the market will bear is a market set price stemming from vendor competition and/or demand for the service. This business is becoming more commoditized, so a sense of urgency exists for both the dealers and the buy side, and I think the market will find a balance between the costs.

But the primary objective here is to consistently understand our client's model, what they need, and how can we deliver it. If we ultimately deliver value, then people will pay a "fair price," which is determined by the market. The market, dealer and the investor community will continue to assess the value that they are deriving from electronic trading and the model, i.e., the balance between dealer pay and/or investor pay will continue to evolve.

Asset Management Group: What trends are on the horizon in the year ahead?

Kelley Millet: A couple of big, strategic questions remain from both the buy and sell side. What role do exchanges have to play in the credit markets? Is the future an increasingly efficient but still principally an OTC market? Or, is there a significant role for exchanges to play? I don't think anybody has an answer at this time. In the short term, I believe the focus on both sides of the table between buy and sell side is to make it a fiercely efficient over-the-counter market. But the question around exchanges remains.

Asset Management Group: How does that question get resolved?

Kelley Millet: It's very difficult because you're trying to change ingrained behavior. The greatest competition we have is changing behavior. There will always be the phone. Large trade sizes, extremely volatile market conditions, and other factors will always exist that make utilizing a long standing relationship between sales person, buy side and trader the best avenue for execution. But TRACE ushered in real change in transparency and the whole nature of margins in the commoditized flow business. We're now in the throes of working with our customers and partners in divining their own individual solutions about how best to deal with the market reality.