The Internet has made good on its promise of unleashing creativity in the financial markets.
By Jeffrey Kutler
March 2001
Institutional Investor Magazine
But years of inventions and start-ups have left behind more electronic trading systems than anyone knows what to do with - causing complications that may take years to untangle.
The good news is that finance is an industry familiar with complexity. Securities operations are so inherently convoluted that even after years of earnest discussion, cooperation and standards-setting, the notion of straight-through processing - automating the entire order flow so as not to require any manual intervention - remains a work in progress. But at least there are measurable results; financial institutions have built enough of an STP foundation to realistically contemplate settling virtually all trades one day after execution - the much ballyhooed T+1 timetable - within a few years.
By contrast, there is no consensus on the proliferation of online trading platforms, except perhaps a general belief that there should be fewer of them. And the final cut will be determined by competition, industry politics and debates on alternative technologies that have only just begun.
Nowhere is the need for a shakeout seen as more evident - or the sense of urgency greater - than in the bond markets. As of last November there were 89 fixed-income electronic trading systems, according to TowerGroup, the Needham, Massachusetts, research firm. By comparison, the equities markets, which have also been dealing with a multiplicity of alternative trading systems, seem downright orderly. Despite widespread assumptions that competition and economics will naturally reduce the number of electronic communications networks, for example, most of their volumes are already concentrated in a few venues, such as Archipelago Holdings, Instinet and Island ECN.
To be sure, stock and bond markets are very different species. Stocks were made to be exchange-traded; bond issues come in much greater numbers and varieties, traditionally traded over the counter. That may help to explain why the Internet spawned so many bond marketplaces.
But in practice, in their attempts to create liquidity in the disparate segments of the fixed-income market, these new exchanges have as yet brought little in the way of market structure improvements or efficiency. Good intentions have only led to more confusion. The Wall Street institutions that with their New Economy gains helped finance many of these programs now have to deal with a glut of markets.
The way out, however, may not be so easy as lumping all the e-markets into a few common categories and neatly rolling them up. The endgame will have as much to do with technology - systems that help institutions manage a continuing high level of complexity - as with free-market forces of consolidation.
“The fixed-income markets can’t sustain 80-plus electronic trading platforms. There won’t be more than a handful of winners,” predicts Richard McVey, founder and chief executive officer of Market Axess, a research and trading portal that went live in November and seems likely to be one of the survivors. “It’s great to be well capitalized in this market,” says McVey, whose ownership group includes Credit Suisse First Boston, Deutsche Bank, J.P. Morgan Chase & Co. and UBS Warburg.
In January, Market Axess began to do its bit for consolidation by agreeing to acquire Trading Edge, owner of the BondLink platform. (In a case of convenient synergy, CSFB was Trading Edge’s merger adviser. Market Axess, a product of the old J.P. Morgan’s LabMorgan incubator, was advised by J.P. Morgan Chase.) The enlarged Market Axess, with 500 participating institutions, is facing off against BondBook, a joint venture of the MGM dealers - Merrill Lynch & Co., Goldman Sachs Group and Morgan Stanley Dean Witter - as well as Deutsche Bank and Salomon Smith Barney.
BondBook, nearing its launch after more than a year in development, has taken pains to draw in institutional investors. It formed a buy-side advisory board and hired as its CEO John Kim, the former head of Aeltus Investment Management. Says Kim: “If this was just about the liquidity of five sell-side firms, BondBook would be just another interdealer market. We’re building something transformational - an anonymous marketplace in which the buy side will be creating its own liquidity.”
Others are just as optimistic. Some, such as BondLink’s anonymous marketplace and TradeWeb in the U.S. Treasuries market, already have two-year track records. Garban-Intercapital says that its international, multi-instrument Electronic Trading Community is satisfying 70 firms with its liquidity pools. “We’re the only interdealer broker that lets you go on the Web, log in and actually start trading,” says Christopher Ferreri, who has been managing ETC for the last two years.
Hovering in the shadows of the giants are the likes of East Lansing, Michigan, broker-dealer Cambridge Group Investments, which says that its real-time Internet trading platform, Bondpage.com, is affordable to smaller players. Its first of a planned series of links to liquidity pools is with eSpeed, the New York-based technology spin-off of Cantor Fitzgerald.
“We’re just trying to fill our customers’ needs with search capabilities and transparency,” says Thomas Blasen, president of Cambridge, which also offers a higher-end version of Bondpage to large institutions. “The different platforms have been based on the expertise of the people involved, whether that’s in municipals or other instruments, or maybe in technology or integration. They all got into a land grab, but none of it would be of any use if there was no liquidity. It’s liquidity that will separate the winners from the losers.”
Of course, traders won’t put up with having to bounce around even as few as five different screens. “They want it all as one-stop shopping, with straight-through processing,” Blasen adds.
Louis Eccleston of Bloomberg, in his role as a service and information provider to some 150,000 desktops, offers to be as flexible as necessary to help customers connect to the systems of their choice. Indeed, one of his selling points is that the Bloomberg terminal can be the single point of entry - which he calls a “central display and matching mechanism” - to all markets. But as an observer of the Wall Street scene, Eccleston sees a disaster in the making.
“It’s dot-com all over again,” says the head of Bloomberg’s global transaction and data services group. Citing buy-side wariness, he gives most online marketplaces little chance of achieving adequate liquidity or obtaining enough trading revenue. “They’ll hope to do IPOs and make money on the platforms - and that doesn’t sound smart these days,” he adds.
Stephen Lynner, president of Thomson Financial’s sales and trading group, is also skeptical that a network of just five dealers can satisfy investors’ need for “breadth of content. We think they’ll want to get insight from all 300 on the sell side.”
But as long as they remain fully funded and confident, companies like BondBook and Market Axess are sure to tough it out. (Both have also had to answer questions from the U.S. Justice Department about potential antitrust violations, despite the fragmented state of their business.) BondBook’s Kim argues that multiple competitors can coexist through “virtual consolidation,” with easy access to all platforms through a single workstation. That’s much like Bloomberg’s pitch to serve as a front-end hub into all markets, but Kim asserts that BondBook will be better placed to do it “seamlessly” for users.
The hub idea could lessen the pressure for what Kim calls “corporate consolidation.” But to former Instinet executive Richard Kelly, that’s a cop-out. Hubs are prone to bottlenecks, he says. “We need to bring change to the markets. The hub is status quo - it just replaces phones with computers.” Instead, he proposes a “network model” that uses interconnected technologies to centralize market access and liquidity pools.
Kelly is founder and CEO of New York-based Wofex, which wants to be that central venue, providing links to ECNs, crossing markets and specialists. Kelly says Wofex is weeks from going live after more than a year in development, with financial backing from Media Technology Ventures and Hewlett-Packard Co. Wofex has endured delays, he says, to ensure “more liquidity and stronger partners from day one.”
That kind of talk, though usually and more easily applied to equities, raises the possibility that there is a holy grail, an end-all solution that brings order to the chaos and satisfies everybody. By incorporating existing market elements, Wofex may be more appetizing than was OptiMark, which failed last year because it required too many changes in traditional securities operations.
“Trading is increasingly less homogeneous,” notes Phillip Riese, the former CEO of OptiMark who is now heading AirClic, a wireless technology company in Blue Bell, Pennsylvania. ECNs made their inroads, he says, because “they are extensions and improvements, not fundamentally new systems. Incremental change is possible. A more radical change, like OptiMark, is very difficult to get across.”
Thomson Financial’s Lynner warns against any tampering that might “limit ways of identifying liquidity.” He adds, “Let’s face it, it’s a complicated world.”
And likely to stay that way.
