| Jim Toffey | ||||||
Jim Toffey takes a seat in the conference room of his 51st floor offices in the World Trade Center in downtown Manhattan. His composed manner is the result of increasingly broad recognition that he has helped build what is thus far the only successful multi-bank broker-to-client trading consortium. Back in the mid-1990s he and Lee Olesky, now Europe CEO of Brokertec, persuaded their employer, Credit Suisse First Boston, to allow them to set up an electronic platform to trade US government bonds.
Four years on, he holds success in his hands, and has done so by staying focused and by including several of the big Wall Street firms in his plans as equity owners and board members. By his own admission, there was also a bit of luck. His business now accounts for over 12% of volume of all US treasuries traded in the secondary market.
He’s now expanding into agency bonds, and plans to get into municipal bonds and other liquid credits soon thereafter, including European government bonds. Few would doubt his success, and yet there are few who relish his position.
For Toffey’s TradeWeb now faces its first major challenges as a going concern. And those challenges are going to come from the very firms he has sitting on his board vetting his every move. As much as it has been the bellwether for the rise and rise of institutional electronic trading, so it may well now become the textbook case on the politics of multi-bank consortia.
Back in May the firm was advertising for a foreign exchange product development manager. On the face of it, this was a no-brainer, as any attempt to trade government bonds outside of the US would require some form of forex service. “Investors are portfolio buyers, not just players in the treasuries market,” says Toffey. “They might trade mortgage bonds or agencies against them, as well as European government bonds.” Services such as forex and swaps are crucial to a company trying to service all those needs.
But something happened the week the advert started running: FXall was announced, a dedicated foreign exchange trading platform set up by seven leading players. Three of them sat on TradeWeb’s board: CSFB, Goldman Sachs, and Morgan Stanley Dean Witter. One other board member, Salomon Smith Barney, a division of forex giant Citigroup, was notable by its absence, as was Deutsche Bank, at that time just a provider of prices to TradeWeb but soon promoted to be the seventh board member. In October, these two partnered with Chase Manhattan and Reuters to form a rival to FXall called Atriax.
Five of TradeWeb’s seven board members and investors thus belong to two separate online forex trading platforms, to which they have contributed a significant deal of cash and resources. Toffey does not regard it as a problem. “We can build our own forex service as a complement to our core business. There’s no need for us to have to go to another consortium for it.” But how likely is it that they will be prepared to allow Toffey to develop a rival service for a sub-set of clients using their money?
The second, and arguably greater, challenge arrived just a couple of weeks after FXall. Another group of TradeWeb’s shareholders, this time Goldman Sachs, Merrill Lynch and Morgan Stanley Dean Witter, announced their intention to build a non-treasuries bond trading platform, BondBook, which they hoped would to all intents and purposes become a bond exchange. Initially it will accommodate trading in US corporate and municipal bonds.
At first sight it doesn’t appear to be a threat. TradeWeb deals in government securities, while BondBook plans to create a market place for less liquid bonds. Investors don’t all make the same distinction, however; many will use treasuries or agencies as a hedge against corporate bonds, or want to sell out of the latter into treasuries when markets get rocky. At present they can do all that through a phone call or two to their chosen bank. Doing it on two separate platforms would be cumbersome, slow, and potentially costly. That’s what initially drove the failed merger talks between BondClick and Market Axess.
TradeWeb is also the litmus test for one of the other big questions being asked at present. Are these bank consortia for-profit organizations or just utilities? With the collapse of the internet boom, that issue has been debated more than it was when many were first planned.
Only one of them is definitely one or the other, TheMarkets.com. It’s a portal for distributing US equities research, and contains most of the usual suspects as partners. Research, of course, is basically free for most investors, so any thought of TheMarkets.com trying to turn a profit would be misplaced.
As for the others, few know the answer, although some think they do. “We are definitely a for-profit company,” says Toffey. “It’s not a question of either planning an IPO exit or being a utility. We are a for-profit independent private company.” For-profit companies, quoted or private, are supposed to grow earnings, either by increasing margin or volumes. What happens when your competitors for market share own you?
You hear a different line to Toffey’s from the banks that sit on the TradeWeb board. They view it as a fantastic way to cut costs and maybe reach a few more clients. “TradeWeb’s success is a result of having a trading model which is based on the standard way of buying treasuries, and using technology to allow several dealers to quote at once,” says Ben Wolkowitz, Morgan Stanley Dean Witter’s head of fixed-income e-commerce. “It expedited the process for a highly commoditized market, helping to cut costs, increase competition and as a result improve service to the clients.”
That would seem to imply a utility. And in the end, no matter what Toffey says, ultimately TradeWeb is only as independent as the seven banks want it to be. And all of them have invested in other models: five are in BondBook (Deutsche, Goldman, Merrill, Morgan Stanley, Salomon) and the other two, CSFB and Lehman, are in Market Axess. And most are also in one of the two forex platforms.
That limits Toffey’s scope for expansion considerably, effectively to the highly liquid commoditized markets where spreads are thin: the charge for trading treasuries is down to as low as $5 per $1 million. It does charge the seven non-board member banks to list prices – somewhere between $1.5 million and $2 million is the entry fee per year – but combined these two revenue streams leave little to invest with.
Whether a BondBook or Market Axess turns a tidy profit is not clear either, but both state that they are for-profit models. “We have a very interesting economic model here,” says James Pellicane, co-CEO of BondBook, intimating that there isa good chance for it to make good money, although he usually tries to deflect attention away from the potential for profit. “We’re trying to address the fundamental problems which the bond markets suffer from, such as illiquidity, decentralization and very little price transparency.
“This is a market structure play. That’s where the real benefits to the market makers come from – increasing liquidity, improving straight-through processing and clearing. I doubt the potential contained in the equity stake is foremost in our investors’ minds.”
Perhaps for those sitting on the board already, but for those that do not have a stake there is real concern. “Having a stake in BondBook or Market Axess is a way of replacing money which we made on market making but which will be lost once it goes electronic,” explains one head of investment banking e-commerce at a US investment bank. “That’s why we run them as for-profit businesses. But if an anonymous platform such as BondBook succeeds, it will kill market-making profits for everyone. So if you’re not an equity holder, you lose revenues and you get no compensation for it.” That might explain the strange tactic of launching with three banks only, and then adding first Salomon and then Deutsche two and four months later. Salomon especially was rumoured to be very annoyed at being left out of the discussions leading up to the launch, and pushed hard, and successfully, to be let in. Deutsche’s admittance was no doubt held up by its earlier investment in rival platform Market Axess.
It’s not clear that a for-profit model can be maintained on any of the dealing platforms set up by the banks, or by the independents. “It’s somewhat naive to assume that there’s a lot of upside in having an equity capital stake in these platforms,” says Justin Bull, head of e-commerce at Barclays Capital. “If the technology really does have the ability to make it an open platform, any liquidity provider can be plugged in, then as traffic increases, the costs investors pay go down, and the value of the equity stake is small if anything at all.”
