Who are inter-dealer brokers?
In trading and investments, we will mostly encounter people who come in between transactions to facilitate. There are regular ones, and there are specialized ones that we call inter-dealer brokers. These financial intermediaries facilitate trades between broker-dealers, investment banks, and important financial institutions. The work of IDBs is nowhere from simple as they deal with massive security blocks with low trading volume. They can also help clients who want to trade anonymously. With that being said, IDBs would usually focus on trades without using a formal exchange or market maker system. On the other hand, they can also work as common agents for significant trades on exchanges. Aside from exchanges, IDBs also work in OTC or over-the-counter markets. They also service municipal, corporate, government, and other bonds.
What are the different roles of an IDB?
The scope of IDBs’ work is vast. They assist and arrange trade so they can execute them later on for institutional clients. And since IDBs are usually agencies, their work does not start with their own ideas. Clients, especially institutional ones, reach out to them ask for their help with orders. Clients can also be investment banks trading desks, hedge funds, insurance firms, and the like. There are IDBs that can go so far as committing capital on specific orders for the client. This is a risky decision because they take positions temporarily to fill a client. Later on, they can transfer that position to another customer or the market.
We mentioned that IDBs also work in the OTC market. They play a significant role for clients who want to engage in this type of market. They need to provide price information and liquidity aside from trading privacy. Why? OTC markets are decentralized. There is lesser liquidity and transparency. If we think about it, IBDs act as small exchanges where one can find bids and offers for their activities. Aside from being small exchanges, they are also like market makers because they need to buy from one dealer to sell to another.
Another work of IDBs involves less popular fixed-income products. They help when the products are too specialized and rare that it can be hard to attract massive market participants. IDBs connect buyers and sellers involved in this kind of product. They need to match a willing buyer to a motivated seller so the transaction will push through. Hence, they make a create price for securities that are not liquid enough.
What else can an IDB do?
IDBs smoothen the market when there are issues. They are usually the only ones willing to buy undervalued securities. We note that this does not include the IDBs involved with municipal bonds. They are willing to take risks while hoping that the market will become stable later on. If the market really did become stable, they generate profits from the bonds aside from their commission from buying and selling to dealer banks. Hence, they provide liquidity during an intense period.