Few Euro-CP dealing houses are profitable, and this week, when speaking to MTNWeek, the market's issuers were blamed. The issuers hit back saying it is the dealers who cut fees or under-price paper, and that they should be willing to take the responsibility. It is a tug-of-war where the dealers are having to pull uphill, and while competition remains as intense as it is, profitability in the Euro-CP market will stay close to zero. Some dealers are now attempting to change this. Houses that run their desks for profit claim business could be more profitable if dealers and issuers found a common pricing protocol. The only way to do this, according to the dealers, lies with the issuers. One trader, who is sensitive to the contentious nature of this topic and asked not to be named, says: "It is paramount for issuers to make sure the pricing of their paper is consistent between dealers. They need to be able to police their prices, and reducing the number of dealers on the panel is the only way to achieve this." Very few borrowers trace the pricing of their notes once they have given their dealers their instructions, because the time required to monitor six or sometimes eight dealers every day can be excessive. By using fewer dealers it would be easier for them to scrutinize the prices being posted and ensure consistency. This view is a common one throughout the dealing community and Steven Anthoney, head of Euro-CP trading at JPMorgan, thinks because dealers are set in their price-cutting ways, issuers have to be the ones to readjust. He says: "I believe there should be a market standard fee structure between three and five basis points as in the US CP market. But it is proving difficult to implement in ECP because of the number of participants, so all we can do is convince issuers that they would have better price discipline if they used fewer dealers." But reducing potential business sources does not sit well with issuers. Kieran O'Donnell is treasurer at Sigma Finance Corp. It is acknowledged as being one of the best issuers at keeping its prices constant, but O'Donnell thinks placing the blame on issuers is wrong. He says: "It's a weak argument for a dealer to say it is purely the responsibility of the issuer to keep prices maintained. It's a two-way street, and if dealers want to increase their profit, getting rid of fee-cutting is one of the decisions they can make." Nevertheless issuers have the power to penalize dealers if they are found to be misbehaving. O'Donnell takes a strong stance if he finds his paper trading cheaper than he wants: "We strongly believe in having a fixed fee, and any dealer who is found to be cheapening our paper will have restricted access to our programme for a period of time," he says. It is a policy that the more profitable houses would like to see put into practice by all issuers. The problem as it stands is that many dealers do not adhere to the theoretical three basis point standard fee for trades. Some dealers, who are only concerned with processing the maximum volume of business, waive fees or cut the price of paper giving investors better yields than other dealers. Although it may cost the dealer money, these methods produce business that the dealer might not otherwise have won. It is a good strategy for those banks that use CP as a relationship tool for winning longer-dated business elsewhere in the bank, or for those that lack other ways of increasing their market share. But it means that gradually fees are eroded away. Jim Gibbons, head of treasury at K2 Corporation, says: "To a certain degree you can only hope that no undercutting goes on as not many people try to police fees. But when you understand that it's a three basis point market it's pretty childish to then go ahead and undercut the competition." Lehman Brothers is one of the most profitable dealing houses in the market and Jon Ford, head of euro money markets at the bank, is frustrated by the methods used by his competitors to win business. He says: "The question that vexes everyone is how do we insert fees into the marketplace when many shops have abandoned profitability." The only solution so far is for smaller dealer panels, but even this is not as simple as it sounds. Ford continues: "What surprises me is the reluctance of some dealers to discuss this issue for fear of being accused of collusion, when clearly this is not the case." Ford thinks having market-wide agreement on a standard fee of three basis points per trade would be an easy, but essential, first step in making it market practice. The reluctance of traders to talk about it makes this difficult however, even though many issuers have said they would be happy to see it implemented. Gibbons, at K2, says: "I wouldn't mind adopting a US model in Europe, but on an agreement of three basis points." The US model has successfully produced profits in CP for 15 years. The history of profitability in the US, where each business within a bank is evaluated on its profitability on a stand-alone basis, and not on how it could lead to profits elsewhere, means the accepted fee of five basis points per trade has been maintained. And it has been the resolve of the dealers not to waver from this, according to Ford, at Lehman Brothers. He says: "Dealers in the US don't want to get involved in a price war because where does it end? It ends with what we have in Europe, with several different prices for the same paper and a trend for dealers to go for quantity over quality." Unfortunately the intense competition in Europe means this could be the case for some time. Compared with the US there are more dealers working for smaller programmes with less money outstanding, and the hope that the market will blossom in the near future means everyone is jockeying for position. Whether it finally pays off, or whether the market is now condemned to being a loss-leader, remains to be seen. Ford has lost patience with the rest of the dealing community. "If certain dealers are willing to lose money to do a deal, let them," he says. His hopes now lie with the issuers and he trusts they realize the benefits profitable dealers could bring. With more money there is more chance of hiring more high-quality people, and with that comes better service and more time to commit to other aspects of trading such as petitioning for same-day settlement. His final plea is resolute: "I would like to see smaller dealer panels and a commitment by issuers to build up their investors over time. This would involve investor analysis and liquidity analysis as well as an acknowledgement of the service the dealers are providing to build liquidity around that name. That's how you build a high-quality market."
April 19, 2002
