Ethics for pleasure and profit
Those unassuming folk who work on the commercial paper desk of many banks are quietly tearing up the rule book about how debt securities are sold. An often neglected corner of the debt capital markets, Euro-CP is proving a breeding ground for ideas that challenge the entire business model that has long been used for selling bonds.
There is nothing inevitable about the current practice, in which the sales teams of a dozen different banks bombard investors with telephone calls proposing deals. It is the sort of sales-oriented business model commonly found in markets where products are highly differentiated, complicated and expensive, such as cars, telephone systems or personal pensions. But simpler, more standardized products are usually sold in quite a different way. A greengrocer, for example, puts his efforts into ensuring that fruit and vegetables are visible, clearly labelled and accessible and then simply waits for customers to pick up what they want.
That is the logic behind several initiatives to shift parts of the debt markets onto on-line systems which allow the investor to take the initiative. With dealer spreads falling to one or two basis points for many issues, the Euro-CP market is, apart from government debt, the most commoditized part of the debt markets.
Most investors care little about which issuer they lend to, so long as a borrower of the right credit rating can supply paper of the right maturity in the right currency (though it also helps if the borrower has already been approved by the investor’s credit committee). They don’t expect to pay much to the intermediary who puts them in touch with that issuer. As a result, it is becoming ever harder to justify the costs of employing a CP sales force.
Earlier this year Warburg Dillon Read took the plunge. The firm got rid of much of its CP sales force and set up a website to allow investors to see what levels borrowers are prepared to issue at on any given day. Some rivals dismiss the new system as no more than a gimmick designed to disguise Warburg’s retreat from the CP market and suggest that the firm has lost market share since slashing its sales force. That is a suggestion Warburg fiercely denies, insisting that it remains committed to the CP market and that it has picked up business by using the new system.
Last month Barclays Capital launched its own Euro-CP website, but Louise Mason, associate director at the firm, insists that Barclays will not be sacking sales staff. “If anything, we will be increasing our sales team,” she says. And last month Warburg Dillon Read also launched an MTN website to complement its CP site, as the first step in a plan to extend the concept to new markets.
Colin Withers, head of Euro-CP at Citibank, remains somewhat sceptical of internet-based trading systems. “Most clients want displays, but they still prefer to deal by telephone,” he says.
But Stuart Clenaghan, executive director of fixed-income distribution at Warburg Dillon Read, believes the new websites offer a better service to investors than the old way of doing things. Previously, if an investor expressed an interest in buying, say, three-month sterling-denominated commercial paper yielding a certain level, a salesman would put together a list of potential issuers manually and fax it to the client. If there were no natural issuers of sterling in that maturity he would price in a currency swap, working out the rate on a calculator. The whole process could easily take 30 minutes.
Using either Warburg’s or Barclays’ websites an investor can quickly sort the list of CP borrowers by name, currency, credit rating and other criteria. But then comes the slow part. If the investor wants to trade, he still usually phones through his order.
The holy grail of web-based dealing is straight-through processing. Using Barclays’ system the investor can make his order by e-mail and in the Warburg version he can communicate directly with the CP trader using a chat facility. But both systems fail the coffee-break test. If the bankers are taking a coffee break, the trade doesn’t get done.
But straight-through processing is tricky for legal rather than technical reasons. Unless the bank puts its own balance sheet on the line for every deal, each trade needs to be confirmed by the issuer. Both Mason and Clenaghan hint that they are working on ways to fully automate the process.
For now, these systems are more like window displays than weigh-and-pay vegetable stalls. And competitors scoff that they have had a perfectly adequate means for several years of letting investors know the levels issuers are prepared to trade at. Most banks post their levels on a Bloomberg page. But Clenaghan says Bloomberg does not have the flexibility of an HTML-based system. “The format on Bloomberg is limiting,” he says. “Investors can sort it but it is more complicated than on our website.”
Mason at Barclays Capital points out that only larger institutional investors have a Bloomberg screen. “We want all investors, including corporates for example, to have access to these prices,” she says. “The internet is something that everyone has on their desks.”
And what is more important, Bloomberg’s system is geared up to use only one currency. Banks have to post a separate entry for the levels of each issuer in each currency. That is not a problem in the US domestic market where all trades are in dollars, but international investors often need to buy commercial paper in conjunction with a foreign-exchange swap.
On their websites, Warburg Dillon Read and Barclays Capital allow spot and forward foreign exchange prices to feed into the CP prices, so an investor can get a price instantly for any combination of issuer and currency he chooses. If he wants to buy six-month British Telecom paper in euros, a currency BT would not normally issue, he can find a price.
Likewise, on Warburg’s new website, MTN prices interact with interest rate swaps and currency basis swaps, to provide prices for issues swapped into the investor’s preferred currency.
Where these websites differ from other attempts to move debt trading on-line is that they remain proprietary. “What they have done is build an electronic salesman,” says Michael Paull, managing director for European fixed-income markets at Instinet which is setting up a fixed-income brokerage network. “They are one-to-many products whereas ours is a many-to-many product.”
What would turn these websites into something more than a means of distributing paper to existing customers more efficiently would be to allow issuers to post their own levels directly on the webpage and then carry out trades in response to investors’ requests. The banks would then effectively become exchanges, competing to attract issuers and investors on the basis of the technical quality of their systems, and taking only a tiny commission on each trade.
Neither Warburg Dillon Read nor Barclays Capital is willing to make such a step at the moment, but both are eager to press ahead with the next stages of their on-line projects. They face an immediate technical problem, however. Banks are banned from introducing new technology for several weeks on either side of New Year lest it aggravate any Y2K problems. The move of CP and other commoditized debt markets into cyberspace will have to be put on hold while the world celebrates the new millennium.
Michael Peterson
