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Headline: E-bonds - Banks struggle to deliver their internet promises
Source: Euromoney
Date: June 2000
Author: Peter Lee
At the start of 2000, many banks trumpeted their ability to distribute new bond issues online, fearful of being left behind by eager issuers. At the same time their trading sides announced, often with great fanfare, their own new internet-based trading sites and new multi-dealer platforms put together among consortia of banks. Since then, banks have struggled to deliver on these systems and to integrate them properly. Some now think the internet will merely make the existing market model more efficient, not overthrow it. But a few still hanker for revolutionary change in the bond market. Peter Lee reports
It may be an apocryphal story, an urban legend of the modern fixed income markets, but the head of e-bonds at a bulge bracket US investment bank nevertheless tells it with real relish, as if it happened to his best friend, or, more likely, his worst enemy. "I've heard of one salesman at a leading firm working on an e-bond who took an order from a major global asset manager for several hundred million dollars. The investor wanted this to be the lead order in the transaction. The salesman said the firm was delighted with the order but please could the client go back and input it online, because this was, after-all, an e-bond deal. The account was so annoyed, he just put the phone down."
The lead manager lost the order that could have priced the deal. The salesman must have had a very uncomfortable conversation with his boss while they worked out what to tell the issuer.
Talk to bond traders and syndicaters about their frantic efforts earlier this year to stake claims as leaders in trading and distributing bonds on the internet and you will soon here several variations of this tale. Whether it actually happened or not - and it probably did, many times over - the story contains the kernel of two key truths about the bond markets' transition to the internet in 2000. Firstly, to certain key market participants - notably the large institutional bond investors - being able to deal on the internet ranks somewhere between a non-event and a mild setback.
Second, bankers at the leading firms have been so desperate to show their internet-capability that they have at times given up all common sense and lost sight of what they were really trying to achieve.
The recently appointed head of internet securities activities at another bulge bracket firm says: "In a few years time we will look back at this period and just laugh at much of what we were doing." He arrived at his new employers in March: "One of the first things I did here was stop salesmen going back to clients and asking them to resubmit orders via the internet that they had already placed over the phone. Salesmen were doing that in an effort to boost the appearance of internet revenue." Here was the internet, supposedly this great engine of efficiency, leading to duplication of effort, waste and confusion.
Having put a stop to this stupidity, the newcomer quickly spotted another flaw in the bank's approach. "We had one system for taking online orders and then another internal system for book building and allocations." Having pushed investors to deliver orders via the internet, the firm then had to take all this information off-line and re-enter it into its internal systems. Meanwhile salesmen had been separately logging conventional phone orders into the internal system, creating a potential confusion as to the true state of the overall book. The internet chief goes on: "It was actually a simple task to build a bridge between the two and then to make sure that salesmen have just one system for inputting orders into the central book." But this was the kind of simple task that was overlooked in the scramble onto the internet at the start of the year, when glitzy announcements of big internet initiatives were more important than real progress at the coal face.
That's where the hard work is being done now. A banker at another firm admits: "If you go onto a lot of the single-dealer sites even now you're likely to find that on any given morning the prices won't be there, or you can't execute, perhaps because there's a problem with the price feed, or the firewalls have fallen over. At the moment, institutional investors will be reasonably forgiving. They'll give you another chance and another. But their patience may wear out. Banks rushed out these sites - and some haven't even managed to do that - now they have to make sure they work properly."
What drove this collective scramble by bond firms was firstly their desire to reach more new clients and to serve existing clients more efficiently so cutting costs, partly their own insecurity and fear of being disintermediated by the web, but mainly pressure from bond issuers, especially the larger and more frequent borrowers who had watched equity volumes expand exponentially with greater ease of access to the markets for small investors dealing online. These issuers had convinced themselves that the internet might help them to reach more new bond investors. Issuers such as Freddie Mac, Ford Motor Credit and the World Bank were among the leaders in this charge.
From the summer of 1999, the World Bank had been seeking ways to use the internet to distribute bonds in new ways. Initially its treasury officials were disappointed to find that few banks e-teams were focused on bonds, that there was wide disparity in technical preparedness among banks. It persisted, because, according to treasurer Gumersindo Oliveros: "we believed (and still firmly believe) that e-commerce is a powerful tool for the development of capital markets, it is changing them in a fundamental way and it is a great opportunity to be in a position to help shape the outcome. The Bank's borrowing operations also benefit from externalities that come with innovation and applying cutting edge technology". It aimed to produce an internet new issue method that integrated marketing, distribution, bookbuilding and trading, which would allow investors to place orders at the click of a mouse, deliver real-time information on the book to the borrower and provide a clearing house for information on the deal to all interested parties.
North American concentration
The World Bank decided to concentrate on more internet-friendly North American investors and eventually worked through a list of 14 possible lead managers down to two: Goldman Sachs and Lehman. It launched in January and found one third of all orders for the deal coming through the internet. (This rose to 50% of orders on a second e-bond in February.) The World Bank calculates that new investors - middle market institutions and retail buyers - accounted for 21% of its first deal. Also the deal traded electronically immediately after pricing with 22 e-trades on the first day.
The World Bank's weeding out of prospective lead managers for this deal sent a powerful message to the banks. Oliveros recalls: "It resulted in the exclusion of some important banks because they were not technologically e-ready, although 50% of bonds were sold over the phone. It is true that in the final weeks we were under a lot of pressure to include those banks that were trying to catch up technologically. However, by acknowledging the banks that had made the investment earlier and were more technologically prepared, the exclusion actually served as an important catalyst for change. Time has validated this strategy since major banks re-oriented priorities and have made a major effort to develop electronic distribution capability since then. The development of electronic trading platforms is also coming along, although at a slower pace."
If banks had been slow to think about applications of the internet to fixed income markets in 1999, they paid attention when issuers like the World Bank began using internet capability as a deciding factor in new issue mandates. The scramble was on.
"Everyone came out of Y2K and rushed out a variety of things on the internet - some genuinely new, some rather old, some that did work, some that didn't - and there was a rash of announcements culminating roughly with the unveiling of BondClick," recalls Justin Bull, head of e-fixed income at Barclays Capital. "Since then there has been a reappraisal as banks think more carefully about what they are trying to achieve."
BondClick is a European-based multi-dealer system for trading government bonds due to launch later this year, modeled as a European equivalent to TradeWeb, a US government bond trading market that remains one of the few multi-dealer systems actually working. None of TradeWeb's founder members are part of BondClick.
Internet-based bond trading systems fall into three main groups. There are single-dealer single-product sites - like Deutsche's Autobahn and JP Morgan's JP Morgan bondeXpress - which are up and running and already account for a large portion of those banks' business in government bond trading. There are single product, multi-dealer sites, many of which, like MarketAxess, have been announced but aren't working yet. And several banks are making strides integrating their various single product sites into multi-product single dealer sites - like CSFB's PrimeTrade, covering derivatives, foreign exchange, government and credit bonds, and in some cases equity and equity derivatives.
"Single dealer sites are just the first step in a marathon race," says Kelly Martin, global head of fixed income at Merrill Lynch. "You have to add to them. At the very least firms will have to provide single access points to clients for multiple products." He goes on: "Ultimately what clients want in many products is liquidity. They don't much care whether that comes from dealers or other investors. I'm a great believer in setting up central locations for liquidity where clients can sell to clients or anyone else. Any dealer which thinks it can continue to be the centre for liquidity is not seeing the whole picture. It's not a sustainable model that our major value proposition to clients is that we provide liquidity." But according to Martin, multi-dealer sites, which in theory should offer the prospect of greater price transparency and liquidity by linking to several dealers at once, have one serious drawback. "If you have 10-12 partners in a venture, you can find 10-12 different views of what it's supposed to be, ranging from those who want to see revolutionary change to those who want slow change."
It remains to be seen which of these three models will prove most significant or whether yet another will appear. Richard Berliand, head of brokerage Europe at JP Morgan says: "The execution arm of a specialist government bond or forex overlay manager at a UK institutional investor, who mainly cares about pure execution, will want the single product, multi-dealer site because he is chiefly interested in best price. However, the person at the Swiss or Luxembourg-based private bank who any day might have to execute for a client, index futures on the Nikkei, hedging the dollar/yen rate and buying the latest EIB Eurobond, may want the multi-product, single dealers site as it provides best range of product availability. Thus there may be room for several different models appealing to different customer segments."
Before testing these models against each other, banks have to build them out. On all but the single product single dealer sites, there's been more talk than action.
Banks have been reassessing both the difficulties of delivering on some of the systems they were spurred to announce even before they were fully-operational and also the limits of what these might produce. Bull says: "On the primary side, you have to ask: if you go through a secure-password route are you really going to reach a wider audience?" William White, global head of syndicate at Morgan Stanley Dean Witter, agrees: "yes the internet broadens our distribution at the mid-market level and smaller accounts can get more access to our business but we have to be very rigorous in knowing who these accounts are."
Worldwide shortage
As for building out systems, banks now face a worldwide shortage of programmers. Progress has been slow both on multi-dealer sites, such as SecuritiesHub, the new issue part of BondHub and MarketAxess, and on proprietary internet-based trading systems. "If you are going to generate live prices updated in real-time and invite investors to trade against them, then you had better also have real straight through processing otherwise you might seriously trip yourself up," warns Bull. "How many firms can really offer that? Believe me, it's not exactly commonplace." He says: "Now, while there appears to be a lull, that's the kind of issue that firms are wrestling with."
That's not to say that the whole move of the bond markets onto the internet has stopped. Far from it: despite the relative quiet after the noise of January and February, there is plenty of work going on. Bull says Barclays Capital itself is working on at least four ECN-type initiatives in the bond market which may come to fruition in the next few months. In June, Merrill Lynch, Morgan Stanley and Goldman Sachs together announced BondBook, an electronic marketplace for trading investment grade and high yield corporate bonds and municipal bonds. The three global bulge bracket firms will provide credit support to the trading system which will allow anonymous dealing for qualifying institutional participants against live prices. Legal and regulatory niceties require BondBook to register as a broker dealer and an alternative trading system (ATS). But it is to all intents and purposes the first stab by big liquidity providers at creating an exchange for bonds.
BondBook is yet another loudly announced system set to actually start trading in the fourth quarter of the year. By this time it may be clearer whether large bond investors want to transfer their dealing onto an electronic network owned by the big dealers. Some have reservations.
Merrill Lynch's Martin, sees a natural self-preservation instinct at work as bold internet concepts slow down in the process of realisation: "At the start of the year there were a lot of discussions at banks and issuers about how the internet world might change many facets of this business. Then when they came back from their off-sites and discussions, individuals asked themselves 'what does this mean for me as an individual? Why should I as a dealer or syndicate professional or as the assistant treasurer of a frequent issuer participate in a venture that's going to take me out of the loop?' That may have slowed things down. But I believe that in the next three to six months a few firms will break out from the pack because they have been through all this internal discussion and are at the point where they know that, however painful it is, they have to fundamentally change they way they do this business."
Martin sketches one of the more revolutionary visions for how the new issue market might change in a way that sounds close to the disintermediation nightmare which should frighten Merrill, regularly the world's biggest bond underwriter, more than any other firm. "I think the big change will be in real time connectivity of demand and supply. If big issuers had the ability to access real-time demand based on indications of interest, and investors could see where primary supply might be, you could create customized markets so that wherever issuer requirements and investor demand cross, you immediately create capital markets transactions." It's clearly a venture taking shape behind the scenes. Martin says: "We're in multiple conversations with parties from within the financial services world and outside it on how to make this kind of network happen and we're a few months away from a really significant new primary market structure." Why should Merrill, which sits at the top of the league tables in the traditional market, promote such a venture? "Precisely because of who we are and how much we have to lose we must be at the forefront of these kinds of developments."
If such an automated new issue market takes off, it should certainly please the frequent issuers, who also are keen to stay closely involved in any internet ventures that change the bond markets. At the start of this year, they were delighted to be able to see fully transparent book-building on their deals. Now they're all looking for the next step forward. Freddie Mac's senior vice president for corporate finance, Jerome Lienhard, sounds a little wistful about developments this year. "These systems are a great tool for issuers and syndicate managers. But they haven't changed the world. And they're a service you quickly get used to. The whole thing with the internet that's frustrating is that we're still very much in the discovery phase. It's very hard in this arena to say: 'this is the ultimate objective, now let's set the game plan to get us there."
At the start of the year, there were two big questions about bonds and the internet. Would the ability to buy and sell online attract new buyers to the fixed income markets? And would issuers find ways to bypass the traditional lead managers and use the internet to sell paper directly to these investors? Nether question has yet been fully answered. But expectations of imminent revolutionary change are a little more muted now than in January.
"While we're very excited about how the buy-side is using the internet for gathering information, research and prospectuses and everyone of our bond deals this year has had an internet component," says William White, head of global syndicate and chairman of debt capital markets e-initiatives at Morgan Stanley Dean Witter, "we can see that the fixed income investor base does not want to click and buy. Investors want to maintain personal relationships with salesmen and syndicate people." Many bankers concludes that the internet has become a tool to support the existing market model, not to overturn it.
Volatile and bearish credit bond markets this year may have reduced investors' interest in dealing online and kept them more interested in sounding out bankers personally to get a closer feel for the momentum behind deals. Large institutions are too worried about their atrocious portfolio performance so far in 2000 to bother spending much time learning to use new internet-based systems which offer them little new value in any case. "The buy-side generally has very good in-house research, proprietary analytical tools and as much if not more market information already electronically delivered than any individual Wall Street firm," says Christopher Lynch, global head of investment grade debt at DLJ. "So throwing more systems at institutions that are already over-armed for battle is redundant."
The main attraction for top tier bond investors to use the internet in future, according to Benjamin Cohen, head of global fixed income and derivatives e-commerce at CSFB, is that it might save them some transaction costs. "If it helps the move to straight through processing, where investors back-office systems have exactly the same instructions as ours, that would cut down on costs from reconciliation errors. Operational costs are a key component of profitability in efficient markets like treasuries and can be high absolute expenses in more complex markets like mortgage bonds." White at Morgan Stanley agrees: "It would really grab the buy-side's attention if we could save them money on processing trades. If there really were a plug and trade utility that would make a big difference, though the buy side isn't yet operationally ready for it and no single firm can provide it."
Still dreaming
Issuers still haven't given up on their dream of using the internet to widen distribution. "Absolutely part of our objective is to get new investors," says Freddie Mac's Lienhard. "I know there are nay-sayers but there is no question in my mind that accessing more investors off internet platforms is the key. At the moment we rely on salesmen to distribute our bonds and they are most likely to call the five people that they know bought our last deal. There's a reluctance to develop new investors. The internet democratizes markets. Share distribution via the internet democratized the equity market and that might be a reasonable model for bonds to follow."
The World Bank has clearly enjoyed some success in this and remains attracted by the prospect. Oliveros says: "There is something powerful to the idea that a small investor in the Mid-West can purchase in the primary offering of a $3 billion bond a ticket for $1,000 alongside a $240 million order by a New York institution, and both pay the same commission."
Market conditions may be becoming more favourable for this development. As equity markets grow more volatile and absolute bond rates rise, bonds might begin to look like a safe, reasonable yielding alternative to equity for online retail buyers. And while it's hard to imagine Goldman Sachs or Morgan Stanley selling bonds online openly to unknown retail customers, it's easier to see them as wholesalers to retail intermediaries, with the internet efficiently linking the lead manager to the ultimate end investors. Schwab, which partnered with Goldman on several groundbreaking e-bonds this year, recently announced plans to sell bonds online.
Issuers and banks are learning the tricks of enticing new smaller investors into bond new issues. Oliveros says: "To get full participation from retail in primary requires significant advanced warning which might not be feasible in all cases. For example, Schwab sent postcards to retail customers giving a heads-up on the deal ahead of launch, much like they do with equity offerings. PaineWebber and others brought in middle market accounts through the net that otherwise would not have had access because they are not large enough to warrant a call from the global houses that generally underwrite these deals."
And in Europe, banks are also seeking ways to reach retail customers. Barclays Capital already has links through the Swiss exchange to offer bond prices to private bankers in Switzerland who ultimately deal with wealthy individuals. And it has other ventures. Bull says: "The holy grail is to be able to access the wider retail base such as Barclays Capital's tie up with Barclays stockbrokers and 27 other regional stockbrokers in the UK or the foreign exchange tie up we have announced with Charles Schwab."
Ford Motor Credit was one of the first e-bond issuers in January with a deal that used Fidelity as a link to retail investors. Jim Bosscher, director of term funding at Ford Motor Credit says: "We were the first corporate to issue an SEC-registered debt transaction using an internet platform. One of the major reasons for doing so was to expand our investor base, including retail accounts who may be potential buyers of our automotive and financial service products."
Ford has been attracted by the notion of cross-marketing, using web sites to market to investors both retail financial investments and its cars at the same time. For over a year customers have been able to buy Ford commercial paper through its own web site, having first established an account using a free phone number.
In June, Ford launched a $4.2 billion bond deal in three and ten-year tranches via the internet using Goldman Sachs as lead manager and Bosscher says he is impressed by the latest internet developments. But even now, he admits, it's hard to quantify the precise benefits of internet distribution, other than in the almost mundane-sounding questions of electronic delivery of associated documents. He says: "I firmly believe using an internet platform allows issuers to reach more investors and provide them with information in a far more timely and efficient basis."
However a more sceptical Ben Cohen at CSFB says: "Most firms have to be able to offer e-bonds because issuers like the idea of getting new investors, but, in reality, the impact of these sites is somewhat limited." And some dealers question whether, if internet systems had not emerged this year, the distribution of these e-deals would have been any different.
Despite that, many firms still hope that they can use the internet to fill out gaps in their investor coverage and catch up with firms that have forged ahead by the traditional time-consuming and expensive route of hiring salesmen. "We've never had a large mid-market sales force, whereas some others do and there are regional dealers that cover specific geographic markets well," says Cohen. "The internet may allow us to get to those quite large groups of customers that would have been more difficult to reach without enormous expense. This effort is now under way."
While banks love the data-mining potential of their proprietary sites, investors only want what works best for them. "We distribute a lot of our fixed income research over the internet to our password-approved clients," says Lynch at DLJ. "We can track the hits and that gives us a good sense of who is interested in what so our salesmen can ring and say; 'I see you've read such-and-such a report, can we follow up with a trade? We had over 1,000 hits on our investment-grade corporate research last month which is great. But now we're finding that some investors don't want to access an internet site for research because it's an extra step for them. They want it e-mailed to them and of course then we can't accurately evaluate the impact."
Almost every bond dealer recognizes that investors want just a few portals into the bond markets, rather than having to deal with large numbers of identification procedures, passwords and clicks to get in and out of separate proprietary sites. "Each firm having its own unique platform is obviously not a winning model," says Lynch at DLJ. "Ultimately there may emerge a central clearing house, which of course would make a lot of the systems already out there redundant."
TradeWeb, a multi-dealer site for dealing in US Treasuries was set up precisely because many investors in the US are required to check prices from at least three sources before dealing. TradeWeb allows this and is now beta testing agency bond trading. Announcements of other multi-dealer sites tumbled out earlier this year.
These mostly envision investors clicking onto a shared portal to see various contributors' research, prices and ultimately new issues and then clicking onto the icons of specific firms to execute deals in their systems. TradeWeb is successfully functioning as a multi-dealer site for government bond trading. Bondhub provides access to many firms' research, but its new issue platform, SecuritiesHub is not up and running and neither is MarketAxess, the trading and ultimately new issue site set up by JP Morgan, Chase and Bear Stearns and which recently attracted UBS Warburg, Deutsche bank and ABN Amro.
"We very much believe in open architecture," says White at Morgan Stanley. "The buy-side would love to have it for reasons including straight through processing. But you have to recognize that these potential open portals don't offer the full technology. In the first stage they will be a portal into banks' proprietary systems and those systems and the open portals have to be up and running. That's not happening at what used to be thought of as internet speed. It won't be done overnight. It will take a while, partly because to make open architecture work requires the whole street to cooperate in ways these firms have not been used to."
And there's another worry here. One internet veteran at a leading firm says: "You don't build web sites by committee. Small surgical teams build web sites and they can't always proceed by consensus. They have to go away and build it and not report back every ten minutes to senior management." That's tricky enough within a single firm, never mind across several competitors.
One or two bankers privately cast doubts on the progress of consortia sites. Some even raise the prospect of inviting other banks to join directly into their own proprietary system as an alternative to the multi-dealer model of the jointly-owned portal with icons for separate firms. That suggestion raises obvious enormous political issues. How far away is that from fully merging the firms?
These are the most hotly-debated issues among the most internet savvy practitioners. Many predict a return to more hectic and more public action in the second half of the year. "I think that integrated platforms will come, that they will come quite quickly and that they'll change the market quite profoundly says Lienhard. "Ultimately I see a blurring of the technology firms, the brokerages and the lead managers and consortia of leading dealers offering live prices and new issues on an open and integrated basis. Investors would be able to download all the information, see the comparable prices and watch the price talk for a new issue, decide whether to buy it and then only finally click on which firm it wants to put the trade through."
After the grand announcements these two integration tasks - first combining their own primary market and secondary trading sites, and then integrating their proprietary sites with multi-dealer portals - might keep the dozen or so leading bond firms that can afford these technology investments busy for the rest of the summer.
CP shows the way for direct issuance
For several years a handful of leading issuers of commercial paper have sold directly to end investors without going through traditional dealers. In May a handful of these issuers banded together to form cpmarket.com an internet platform from which they intend to offer commercial paper directly to the market. The founders include GECC, Ford and GMAC and the designer was Prescient Markets.
GECC has at various times had up to $90 billion of CP outstanding, while the other two may have many tens of billions of dollars worth outstanding. They are a big part of the market. And if cpmarket.com works, it might easily attract other leading corporate issuers quickly. "It's a big and impressive effort for these people to work together - probably the most substantive internet debt markets effort of the last two months. They've completely by-passed the intermediaries," says one treasurer at a frequent issuer who is also exploring ideas with Prescient Markets.
"Ford Credit was the first issuer to offer its commercial paper through the internet. We have also been a leader in the development of cpmarket.com, where investors can purchase the commercial paper of almost 20 direct issuers," says Jim Bosscher, director of term funding at Ford. And while many bond dealers will watch this with mild interest, they might choke at Bosscher's next suggestion that cpmarket.com and its direct issuance model might point the way for future developments in the bond markets. "Like the commercial paper market, I expect the term debt market will evolve from proprietary to more standardized internet sites over time."
He finds an unlikely ally in outlining this vision in Kelly Martin, global head of fixed income at Merrill Lynch, the world's leading bond underwriter and the one with much to lose if bond deals become automated auctions. Nevertheless Martin says Merrill is looking at a network to link frequent issuers and investors so they can quickly execute issues: "CP has been the first because it is the easiest but issuers are going to walk up the curve to intermediate and long-term debt. There will be an e-model where issuers and investors can meet. There's no reason why an automated e-issuing process couldn't occur." He adds: "You might put it together with one or two financial services firms, one or two technology firms. And then it should be open to all. Other firms could use it for a fee or a toll charge."
That would be an uncomfortable prospect for the leading bond firms. It's also one that they and many other regular issuers still find unlikely. "Short-term paper - what corporates call commercial paper and we call discount notes - lends itself to direct issuance much more readily than bonds because it doesn't trade as much. It's more of a pure distribution game," says Jerome Lienhard, senior vice president for corporate finance at Freddie Mac. Freddie Mac doesn't issue directly to the public on an open platform but rather regularly holds internet-based closed auctions to its dealer groups for up to $10-$15 billion of notes on an announced calendar. "It's enormously efficient. There's straight through processing - the only human intervention is to authorize the auction and that realises real productivity gains for us," says Leinhard. But it's a big step from there to direct issuance of long-term bonds.
Buyers tend to take down one week or one month CP, and when it matures buy some more. Buyers don't need to trade it and so they don't need intermediary firms.
The problem with direct issuance of bonds is that while it is perfectly possible technically to hold auctions via the internet, they provide little comfort to investors that they will be able to sell those bonds again, if they need cash. Where should investors go for a price, if there is no lead manager taking responsibility for a deal? And in a volatile bond market, anxiety over liquidity is increasingly acute among investors.
While individual bond trading firms have had their fingers burned by losses on proprietary positions taking in riskier bonds since 1998, the concentration of assets under management among fewer fund managers presents investors with a problem. Large investors might hold $1 billion exposures to credits in which the largest Wall Street firms only run positions of $50 million. Investors want liquidity from whatever source and while they might be prepared to buy small positions in a direct auction, they are less likely to take big blocks of bonds.
If investors are worried by lack of liquidity in directly issued or auctioned bonds, then issuers in turn start to worry that no investors will turn up and bid for internet auctions. Issuers want certainty of proceeds in difficult markets and they certainly don't want the taint of failed deals. Then there's the question of what do they have to gain from auctions? For big frequent issuers price discovery is reasonably efficient. If the five lead banks quote an issuer a likely spread of 80bp over treasuries for a large new issue, an auction isn't going to suddenly deliver demand at 60bp over. "Dutch auctions could even be quite expensive for issuers and certainly they remove the ability to fine tune price to moderate the volatility in market conditions," says Christopher Lynch, global head of investment grade debt at DLJ. The saving is on the fees and fees might be worth paying for the certainty of a conventional deal.
Shortly after the launch of the euro, smaller European governments moved away from auctioning shorter-dated bonds to mandating lead managers to arrange conventional bond deals.
Mind you there are precious few certainties with the internet. Sources say that at least one big issuer is working on an idea to make markets in its own securities to provide some assurance of liquidity to investors if they buy it's bonds directly. And one or two of the banks, who have the most to lose if direct issuance ever takes off, are itching to try bond auctions, simply because they think their internet technology means they can. What they're likely to suggest is internet-based exchange offers, combining bids to buy up certain outstanding off-market bonds and offers to sell new paper. And of course they would charge a fee. "The threat of disintermediation hasn't gone away, but the buy-side isn't looking for it and a difficult market emphasises the role of intermediaries. The threat is much less than we forecast in January," says White.
The internet breeds a new bond culture
The atmosphere on the bond trading floor of UBS Warburg at Broadgate in London on a Friday early in June captures the mood of the times as the bond market moves onto the net. At first glance there's not much going on: beneath the surface it's pretty hectic.
This is as far as you can imagine from Liars' Poker-style bond market bravado, with tense, sweating traders shouting profanely into their phones. You have to listen hard to pick up the action: the sound you hear is of keyboards clicking. UBS Warburg has an open internal chat page, officially called interchange chat but widely-referred to simply as chat, whereby salesmen and traders continuously type in queries and instructions. "The way we use chat is that it's totally open. It allows you to multi-task, to tap in request while doing something else on your screen. It also creates an expectation of a real-time answer," says Stuart Clenaghan, executive director, fixed income e-commerce at UBS Warburg. "It also creates global community. Salespeople, researchers and traders in every office share the same information in real time and can send files or web page URLs."
Facilities like this chat line and in-house video streaming, have subtly changed the atmosphere and culture of the firm. UBS Warburg is increasingly trying to include clients in this interactive community. Some 250 outside institutions can now use chat. UBS Warburg, which developed the facility, thinks it may have applications way beyond banking and has sold a large stake of its equity in the development to a third party, PARLANO, which aims to industrialize it.
Clenaghan opens the main IBOL portal page for UBS Warburg which since May 9th has pulled together the firm's sites for equities, fixed income, treasury and related products and moves quickly to the DebtWeb page. "We're integrating our internal systems with our external facing internet systems," he notes, "so they look the same to people inside the firm and to customers. That's one of the keys to good web development," he adds, like a kindly school-master offering a key revision tip for getting through a daunting chemistry exam.
He clicks on the new issue calendar page and reviews bond deals the firm has led this year. Roughly one third of them, amounting to $30 billion have a note attached to the summary saying they were e-executed. That is they were done in some part over the internet. He clicks on one deal and goes onto the same page an investor would see if he was interested in the deal. This page offers links to the terms and conditions for this deal, rules for submitting orders online, a short summary of the deal and the state of the market, charts for the trading performance of comparable deals, suggestions of possible switches of bonds for the investor to sell out of in order to buy a piece of this new issue. It's all quick and efficient, though one wonders if it offers the big investors any more news and analytics than they already have via Bloomberg and a host of other systems.
Still, if the investor decides to submit an order, he can input demand at varying spread levels. He might want $100 million of the corporate deal at 130bp over treasuries, $200 at $131bp over, $300 at 132bp. The investor submits the order and gets a confirmation e-mail back. If it's going to be a popular deal and the investor is worried about being short-changed in allocation, he can very quickly submit an order to buy $100 million of bonds at whatever the eventual market clearing spread. That date and time of this order will be logged, so if allocations on a hot deal are designed to reward investors who supported the deal early, he should benefit. The investors can later add more price-sensitive orders. It can also add on which benchmark Treasury it is selling or which comparable bond it is switching out of to buy the deal.
UBS Warburg wants to do as much of this business as possible. And though the instinct of many fund managers when buying a new issue from a lead manager is to execute an associated hedge or switch with a different firm, UBS Warburg hopes that investors using this system will at least be more inclined to consider taking its prices for the switch trade.
Something that UBS Warburg hasn't trumpeted too loudly is that its systems allows it to actively monitor client usage. Every time an investor, the issuer, or a UBS Warburg trader or salesman looks at this deal, even if they don't execute an order or any other transaction, there is a record. "We've linked our client relationship management system into this," says Clenaghan. The firm is still exploring the potential for data-mining this kind of information, potentially for prompting salesman to contact investors who have shown clear interest in certain transactions even if they haven't traded. And knowing exactly where bonds were initially sold is enormously helpful to secondary traders.
A survey of the history of the clicks on this deal shows that one user clicked on 62 times over two days. This was the issuer. "Issuers are fascinated by this," says Clenaghan. "And in particular by the ability to see the book build." It allows them at any moment to see the amount of demand at various spread levels, the geographic breakdown of demand, even to look at the individual orders of specific investors and see the price sensitivity of their orders and their likely switches. It means that issuers they may somehow have felt they were being kept a little in the dark by lead managers can see the whole picture just as we see it, they can understand their own investor base better, take a realistic view of market demand, better understand the dynamics of the secondary market and better work out the distribution strengths of the firms they work with."
That's quite impressive. And issuers confirm that this is indeed exactly what excites them about seeing their deals executed online. "It may not sound like much, but it's a big difference to what we've been used to," says Jerome Lienhard, senior vice president for corporate finance at Freddie Mac. "You may have known the same bedroom for many years, but it's still hard to walk around it in the dark. When you get phone reports on a book build, you might miss the really salient points. Now you can see it all. You can really drill down into the demand line by line. And it can be very helpful to see what's coming into the market on switch when you price a deal."
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