A bigger deal in platforms

After three years of consolidation in electronic trading, are brokers getting what they want from the players who are left and do the providers themselves know where they are going?

For the fixed-income trading platform industry, the past three years have been a nasty hangover from the internet boom. Scores of offerings have dropped out of the scene, but as the Bond Market Association (BMA) notes in its most recent report, consolidation has resulted in a core of considerably stronger platforms.

Sang Lee, manager and analyst in the securities and investments group at technology consultancy Celent, believes the carnage is largely over. “Consolidation has stopped,” he says. “There are too few platforms left for it to continue.” The market now appears to be sustainable.

The BMA says there are 77 electronic fixed-income trading systems in the US and Europe, compared with 81 in 2002; of these, 46 are principally focused on the US and 31 on Europe. It notes that the trend towards platforms operating in both markets has continued during 2003. Many of these platforms trade products not of interest to this article, such as the money market, but that still leaves some 39 (29 in the US, 10 in Europe) aimed at the corporate bond market.

Celent’s Lee estimates that electronic trading accounts for around 25% of all bond trading; the corporate bond market remains relatively illiquid with just 5% of total volume traded electronically. By 2007, he expects nearly 60% of all fixed-income trading to be electronic.

The platform market is essentially divided into three sectors: inter-dealer platforms (serving the bank market (see box)), single-dealer platforms (serving institutional investors and some retail brokers and smaller banks) and multi-dealer platforms (primarily serving the investor market). The question is: Are investors getting what they want and need from these providers?

Single-dealer platforms – on the wane?

Single-dealer platforms allow investors to execute transactions directly, with the dealer acting as principal. But in the competitive pricing era of multi-dealer platforms, what role can they play? Lee Olesky, CEO of multi-dealer platform TradeWeb Europe is characteristically forthright on the subject. “Single-dealer platforms are on the wane,” he says. “Customers want price discovery, and single-dealers cannot offer that.”

Rick McVey, CEO of rival multi-dealer platform provider MarketAxess, notes that single-dealer platforms have enjoyed some success in Europe, but he believes the drivers are retail and private clients rather than institutional investors, and that average trade sizes are relatively small. “Institutional investors are, by definition, more sophisticated and competitive and therefore demand price comparison,” he maintains. “In addition, there are regulatory requirements under which they must prove that they have attempted to get the best price.”

But Chris Topple, head of European and North American e-marketing for JP Morgan, points out that they offer clients a greater degree of choice than multi-vendor platforms.

“JpeX is most comprehensive in the credit sphere, where there are around 3,000 instruments on offer, including ABS and, increasingly, JP Morgan structured and derivative products,” Topple says. “That is a far broader offering than on multi-dealer platforms, which tend to focus on vanilla product. We are continually looking to expand it further in non-vanilla products.”

Serge Marston, director of fixed income e-business at Deutsche Bank, which has had considerably success with its Autobahn platform, agrees that a wide range of products is the key to success in the single-dealer market. “We have 5,000 products on our platform, but can only offer a small subset of those on the multi-dealer platforms. As the market becomes more commoditised, the differentiators will be use of technology and the breadth and depth of your offering.”

Topple acknowledges that there has been a migration toward multi-dealer platforms for large institutions seeking to do vanilla business but says that JpeX aims to offer what is not currently available elsewhere. Single-dealer platforms will always be two-to-three years ahead of the multi-dealer market in the products they offer because they can adapt more quickly.

Multi- and single-dealer platform are not necessarily in competition, according to Celent’s Lee. He says that single-dealer platforms exist principally to serve existing clients. “The banks hope to access a broader audience by participating in the multi-dealer platforms,” says Lee. “These platforms could hurt their own offerings in the end, but it doesn’t matter where they sell the product – just that they sell it.”

JP Morgan’s view is that it should and will provide access to its dealer liquidity in whatever way the market wants – whether through multi-dealer platforms or through its own offering. “The majority of our investment in this area has been in developing pricing infrastructure rather than on the platform itself,” says Topple. “To some extent, where the information goes, or where the trade is done, is not that important.”

Inter-dealer platforms – do they matter to the buy-side?

The inter-dealer broker market may appear irrelevant to institutional investors, but it is important in at least two aspects. Firstly, the efficiency – and therefore costs – of inter-dealer trading has an impact on the liquidity and costs of the investor-facing market, either through single-dealer platforms or multi-dealer platforms. Secondly, and most importantly, is the potential for inter-dealer brokers to enter the investor-facing market.

This has already been tried, but the jury is still out on its success. MTS, a trading platform for government and quasi-government bonds that trades e75 billion a day in cash and repo, operates BondVision. It allows institutional investors access to the securities listed on its inter-dealer platform and primarily competes with TradeWeb.

Separately, MTS has tried to enter the corporate bond segment with CoreDeal, a joint venture with ISMA, covering bonds over e1bln. It was closed a year ago, but Allan Malvar, a spokesman for EuroMTS, says the company is prepared to commit to it if and when it sees enough recovery in the market to justify the investment.

That does not mean that the possibility of inter-dealer brokers entering the investor-facing market is finished. “The most obvious threat to the multi-dealer platforms are the inter-dealer brokers because they already have the traffic,” says Sang Lee, manager of the securities and investments group at Celent. “Their only concern would be that dealers might stop using them if they decided to allow investors into the market. But it might be worth the risk for them to try.”

The scale of the inter-dealer market is impressive. “Icap is the world’s largest voice broker and acquired BrokerTec, one of the world’s largest electronic trading systems, in May 2003,” says Garry Jones, CEO of Icap Electronic Broking in Europe. The combined group now trades $550 billion across all products globally every day. “Our objective is to link voice and electronic broking across certain products, and we’ve already completed US Treasuries.”

His colleague Dermot Doherty, director of marketing at BrokerTec Europe, notes: “We continue to expand the range of electronic products on offer. Shortly, we will launch supranational dollar eurobonds. Our intention is always to target the most liquid areas of a market first because that is where the volume is and where electronic broking can have the largest impact.” If a firm of that size enters TradeWeb’s and MarketAxess’ space it could decimate their volumes.

A new battle

Following the collapse of numerous platforms between 2000 and 2002, there are now just two multi-dealer platforms that have credibility, although operations like Bondscape and Bondpage continue to operate. TradeWeb dominates government and agency bonds and MarketAxess is the main port of call for corporate bonds.

The planned entry of TradeWeb into the credit market is about to bring that neat arrangement to an abrupt end. TradeWeb believes it can replicate its success in the Treasuries markets in credit.

“Our view when we established TradeWeb in 1997 was that in order to have a market, you require liquidity providers and customers,” recalls Olesky. “That holds true in every new sector we enter.” He would only say that the launch of TradeWeb’s credit offering in the US market is imminent, but rivals note that the company has been beta testing the product for over a year.

MarketAxess’ McVey views TradeWeb’s launch with equanimity. “There are currently new attempts by some players to gain market acceptance in the credit space by trying to replicate the way MarketAxess does business,” he notes. “But we are confident that we will maintain our leadership position.”

He is eager to point out the differences between the Treasuries and credit markets. “As MarketAxess is only focused on credit, we have expertise in the field and the tools and data specifically designed for the market,” says McVey. “Credit is very different from the rate space. At institutions, the dealers are in a separate unit. In credit, investors are looking for broad-based real-time data. We have built tools to help clients conduct price discovery in the most efficient way, through providing Trace data and dealer inventory information. We also provide secondary loan and CDS information.”

TradeWeb’s Olesky acknowledges that credit is a unique market and says their new product has been specifically designed for it. “It brings in the tools that the buy side needs in order to trade the product,” he says. “Those working in credit need more data. That is why we will be supplying them with Trace data among other things.”

What investors want

Investors are understandably hesitant to talk on the record about their use of trading platforms. Generally, those that Credit spoke to are happy with their experiences of using both single-dealer and multi-dealer platforms. Most would agree with Lee Olesky, CEO of TradeWeb Europe, that liquidity is the most crucial component of any trading system.

MarketAxess contends that its liquidity pool and technology have gained it a large institutional investor following of 700 clients, which CEO Rick McVey claims represents 85% of fixed-income assets under management. For most of the dealers Credit spoke to MarketAxcess was the dominant platform for corporate bonds.

“It’s the only significant platform now in corporate bonds,” says one UK-based portfolio manager, who has around $60 billion in global funds under management in fixed income. “It’s not great in the sterling market in terms of coverage,” he says. “We tend to only do small deals on it – less than £1 million – and we focus mainly on the deals that are difficult to do otherwise. We use it because it makes the process quicker. But when you ve got a large number of credits that you want to sell, it can actually slow the process down because half the bonds might not be on the system.”

McVey points out that a new feature included on MarketAxess should help with this particular problem. “One example of our technology – and how we have responded to investor demand – is our portfolio trading facility,” he says. “This means investors can conduct trades with a wide number of dealers on a large number of securities. Significantly, it replicates the way in which investors already work in the market.”

Portfolio managers are eager to get more out of the system, however. “The ease of use of MarketAxess could do with being improved,” says one. “You can’t just look up a bond using its ticker for example. We have talked to them about trading on spread in the European market – because bond prices really don’t mean anything unless you know where the underlying government bond is and what the yield is – but it proved too difficult to set up. That said, our guy in the US market loves MarketAxess and can’t get enough of it.”

Another London-based trader says that he finds the indicative pricing facility on MarketAxess can be inaccurate. “It relies on the banks to update their prices throughout the day and not all of them do. The prices you see on the screen may not be those the banks will transact at.”

But the rationale for multi-dealer platforms such as MarketAxess appears to have been fully accepted by institutional investors – even if the reality does not live up to expectations. “The concept is great because it offers perfect competition,” says the trader. However, one banker says that for a bank this is a shortcoming. “Multi-dealer platforms enable investors to find out the lowest price available and then contact us and get us to under-bid it,” he says.

To the relief of bankers everywhere, the UK-based portfolio manager says that multi-dealer platforms don’t make sense in all situations. “When you’ve got a big ticket to sell, you don’t necessarily want to go shouting it out in the market,” explains the portfolio manager. “You need to talk to the guys on the dealer desks and gauge the state of the market and how it will react to your sale. Obviously an electronic platform is never going to be able to do that.”

Speaking volumes

Nevertheless, Olesky contends that TradeWeb has huge advantages compared to its rival. It is already established in other fixed-income markets, it is already profitable, has gained the necessary experience, and most importantly has got the biggest dealers in the market on its platform. “It comes down to economics: TradeWeb’s volumes are substantially greater than any of our rivals,” he says.

The impact of TradeWeb’s move into the corporate bond market could be considerable, according to Celent’s Lee. “It will make many institutions question their allegiance to MarketAxess.”

He believes that the challenge for TradeWeb is whether they can leverage their experience in the fixed-income market into the corporate bond market. “They will benefit from not having to rely on only one product, like MarketAxess does,” he notes. “If TradeWeb loses money in corporate bonds for a while, it won’t matter because they have revenue from elsewhere. But if MarketAxess starts losing volume to TradeWeb, it could be difficult for them.”

At MarketAxess, McVey is quick to note that liquidity is the number one concern of customers and that it has assembled the largest pool of aggregated liquidity in the market. “No other platform comes close,” he says. “We are fortunate to work with the leading dealers in the market and that is exactly what the market wants: all the major dealers on one platform.”

MarketAxess claims that the 18 dealers signed up to provide liquidity on its platform account for some 99% of new-issue, corporate-bond, secondary-trading volume.

Competitive game

But that is no guarantee that the dealers signed up to their platform will put all their liquidity into it. “Look at what happened to BondBook,” recalls Lee. “It was backed by the largest dealers and was meant to have guaranteed liquidity but it shut down after 9/11 because there was little appetite for risk taking.”

Two potential threats to both TradeWeb and MarketAxess are Bloomberg and Reuters. Bloomberg is currently the most significant; it already operates a multi-dealer trading system for sovereigns, credit and many other asset classes. The firm has put increased emphasis on its fixed-income trading, according to Russel Levi, recently appointed head of fixed-income electronic trading at Bloomberg. Trading on Bloomberg is free to both dealers and the buy side. “We are aware that the buy side needs to be able to show best execution and facilitate price discovery, and we offer that,” says Levi. In mid-November, the platform hit a record in the government and credit-trading market of 80,000 trades a week in Europe.

All prices on Bloomberg are fully executable and dealers can ensure that only selected clients see prices or can trade. “We’ve also launched a system to allow investors to request multiple quotes from multiple dealers,” says Levi. At the moment it is only available for government bonds but it will be introduced in credit early next year.

By the time this article is on your desk, Bloomberg will also have launched a new service to allow dealers to communicate their inventory to customers. “It will allow investors to co-mingle responses and inventory,” says Levi.

One trader at a UK-based global fund manager says Bloomberg’s new found enthusiasm for fixed-income trading could change everything. “Most people have Bloomberg and are happy with the way it works. If it could find liquidity in the credit space, a lot of investors could switch to it reasonably easily. No-one has real loyalty to the systems they are using now. After all, they have only been going a few years. And everyone is open to ideas that offer greater liquidity and potentially lower costs.”

The future – a fixed-income exchange?

Celent’s Lee notes that fixed income is currently an over-the-counter market. “The ultimate goal of any of these players is to become a fixed-income exchange, and any player that achieves that will be well rewarded,” he says. Of course, structural changes would be necessary for any of the inter-dealer brokers to move from the inter-deal market to the investor-facing (business to consumer or B2C) market. As Garry Jones, CEO of Icap Electronic Broking in Europe, explains: “The B2C trading model is very different to ours. It is mostly a request-for-quote market, while we use an open offer method. In most of our markets, banks must be members of the central counterparty – the membership of which is restricted to banks.”

TradeWeb’s Olesky says that the inter-broker market remains a competitive threat, whatever inter-dealer brokers say about the problems of entering the investor-facing market. “There are technology and other issues that separate the inter-dealer broker market and the customer-facing market, but it would not be a big jump to move from one to the other.”

Worryingly for TradeWeb and MarketAxess, Icap’s Jones agrees. “Until now we’ve always been solely in the B2B market,” he says. “However, the boundaries between B2B and B2C are changing, not least because smaller banks may well be customers of the larger banks.”

Anonymous trade

McVey at MarketAxess predicts that at some point there will be a link between the inter-dealer market and the institutional investor-facing market using an anonymous exchange-style model. “There have been attempts to use anonymous trading in the investor market and, no doubt, in the future there will be a re-emergence of demand from investors for such a market – as there will be for an integrated electronic platform serving both banks and investors,” he says.

Whatever happens, Olesky says that the competitive landscape has changed substantially in recent years. “The trend is for more competition and for the biggest players to cover more asset classes,” he says. “The benefits to the market will be increased efficiency and transparency, and everyone welcomes that.”

Fix – mixing things up

In April 2003, Fix 4.4 was released bringing the protocol – which allows investors to send requests for quotes to a number of banks using one standard – into the fixed-income market for the first time.

“The Fix 4.2/4.4 protocols, which encompass fixed income, could potentially be a major threat to the multi-dealer market,” says Chris Topple, head of European and North American e-marketing at JP Morgan. “It will allow large institutions that have Fix connections to the banks – which is any institution that trades equity – to send requests for fixed-income instruments,” he says. “It could effectively create a multi-dealer application without the fees. At the moment it is still in its infancy in fixed income, but by 2005 it could be significant.”

But Lee Olesky, CEO of TradeWeb Europe replies that the company does not view Fix as a competitive threat and uses the protocol with its clients. Indeed, he claims, the company was involved in its development.