Traditional Brokers Sprint to Online Bond-Trading Finish Line
By Gregg Wirth
Staff Reporter
After watching online brokers bite into their stock-trading market share, traditional brokers are sprinting to capture the online bond-trading market first.
Almost every traditional broker is working on some sort of online bond-trading initiative, including Merrill Lynch (NYSE:MER - news) , Bear Stearns (NYSE:BSC - news) and J.P. Morgan (NYSE:JPM - news) .
"Once bitten, twice shy," says John Ladensack, Schwab's (NYSE:SCH - news) senior vice president of fixed income. "Clearly, the success of Internet stock trading caught some of these firms flat-footed." Easy for him to say; Schwab was at the forefront of the online trading revolution.
There's a good reason the traditional brokers are attacking. Fixed-income offerings annually make up a $1.5 trillion market, and bond bankers -- obviously only the traditional firms so far -- pocket about $25 billion in fees a year.
The shift to online bond trading also could solve one of the biggest problems facing people who want to trade bonds. Currently, bond buyers have to make numerous phone calls, getting quotes from individual bond brokers, and then compare prices. This lack of coordinated pricing has led to high markups on bond prices in the secondary market.
For now, much of the innovation will go toward getting online bond systems up and running for institutional investors, which do the majority of bond buying and trading compared with retail investors. But these ultimately will make it much easier for retail investors to buy bonds online.
As recently as a year ago, investors' access was limited to a few U.S. Treasuries that traded online. Since then, however, the number of online bond offerings has been growing in size and frequency, culminating in a blockbuster $3 billion offer by the World Bank through a variety of online underwriters in mid-January.
And in recent weeks, the traditional firms have begun rushing in. For instance, when Merrill announced its iDeal system, which allows institutional investors to trade online, the firm stressed the fixed-income component. "This will level the playing field for all investors wanting fixed-income securities," says James Quigley, head of Merrill's global debt capital markets.
Wall Street hopes to model its online bond business on electronic communication networks, or ECNs, which allow investors to post bids and offers on stocks on a single electronic platform. Several Wall Street firms are partnering up to offer online trading platforms for fixed-income securities that will, by pooling prices and offerings, potentially feature more and better deals for customers.
A few weeks ago, three of the largest bond-market underwriters -- Bear Stearns, Chase (NYSE:CMB - news) and J.P. Morgan -- joined to launch the MarketAxess trading system.
In November, PaineWebber (NYSE:PWJ - news) , Goldman Sachs (NYSE:GS - news) , Spear Leeds & Kellog and BondExchange created BondDesk.com. Like MarketAxess, BondDesk will put bond brokers in direct competition with each other on the same electronic platform, allowing investors to choose among several dealers for the best price.
And last week, Softbank and Lehman Brothers (NYSE:LEH - news) announced a joint venture to create an online trading platform in Japan for institutional dealers and investors who want to trade Japanese bonds.
Of course, some of the online brokerages, such as Schwab, E*Trade (Nasdaq:EGRP - news) and DLJdirect (NYSE:DIR - news) , have bond-buying features, which is what worries the Merrills of the world. And newly created players such as eBondtrade.com and TradeWeb have sprung up to trade everything from munis to Treasuries.
Marilyn Cohen, president of Envision Capital Management, a fixed-income money-management firm, says she hopes online bond systems will give her more access to offerings and better pricing in the secondary market.
Mid-sized bond buyers such as Cohen grew tired of seeing the biggest investors get away with paying a lower price on bonds simply because of the large amount they were buying, a phenomenon not seen in the more transparent world of stocks, Cohen says. "Customers started to really demand an online bond-trading system."
And if something is inevitable, Wall Street now figures, it's better to adapt sooner rather than later. "The cost of entry will be dearer in the future, and Wall Street knows it," says Schwab's Ladensack. "For now, that leaves the traditional firms scrambling to find ways to be innovative in the face of new technology."
Either way, the one thing Wall Street doesn't want to do is sit back on its fat fees and dictate what clients pay. Traditional firms tried that route with stocks, and now, every time they see one of those Stuart ads from Ameritrade (Nasdaq:AMTD - news) , they wince and remember the painful lesson.
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