The market turned a corner in 1999 with the launch of the first online trading system for Euro-MTNs. And by the end of this year it is expected that all major banks will have internet dealing capabilities. For traders it could be a case of sink or surf. But banks must watch out that technology doesn't become their worst enemy. If market pressure leads to one central online system dealers may end up causing their own disintermediation. Over the next few years significant changes are set to take place in the way business is done. Online systems will give investors an extra way of communicating with dealers and buying notes. Warburg Dillon Read (WDR) was first off the starting blocks into online trading for Euro-MTNs. It launched its system on October 21 1999. But other firms have been quick to follow in its footsteps, including BNP Paribas Group (BPG), which is rolling out IssueMaster to its clients, Credit Suisse First Boston with PrimeDebt, Merrill Lynch with its Ideal system, and Morgan Stanley Dean Witter (MSDW) with ClientLink. Yet problems could lie ahead. If banks show different pricing levels for the same issuers it will create confusion rather than transparency. And in the event of this the market will demand one common system. Marc Falconer, director, Euro-MTNs, at Salomon Smith Barney (SSB), believes this is a strong possibility. He says: "It would require the co-operation of several market leaders. It would be a fine show of foresight by the market." But Daniel Cogoi, global head of Euro-MTNs, at BPG, is concerned about the implications. He says: "Eventually when all banks have online trading there'll be room for less than 10 main players. But the really interesting part will be whether we move towards having one common online marketplace in the future. This could damage the dealer's own business, let's hope dealers act accordingly." At the end of February 2000, WDR claimed to have generated $1.5 billion-worth of Euro-MTN business from its internet trading system. But while revelling in its early lead, the bank is looking ahead. It knows it cannot afford to sit back and become complacent. Gavin Eddy is executive director and head of Euro-MTNs, at WDR. He left Merrill Lynch in May, last year, to launch WDR's web trading system and head up the desk. He says: "An adventurous bank might look to float their trading platform in a few years as a joint venture with other dealers. With a common platform and live pricing feeds from each of the dealers, execution would simply become a function of the best swaps and derivatives pricing. This would dramatically squeeze out marginal players. In a commoditized market like Euro-CP this could be a reality, but I think the complexity of the Euro-MTN market will make the process slower." While investors and dealers may be keen to increase the efficiency of trading through online systems, most banks admit that many issuers have concerns about the technology for various reasons. Eddy, at WDR, explains that this was worse in the early days. "Being the first bank to move in this arena, WDR had to address issuers' fears and anxieties. However, the majority of borrowers are positive. Most realize this is the way the market is developing. It caused a bit of a storm at the beginning but there aren't many who have reservations about our system now," he says. But Michael John Lytle, vice-president, Euro-MTNs, at MSDW, points out that one particular portion of borrowers will be badly hit. He says: "In general, the issuers' response has been positive. But some issuers are suspicious and nervous, especially arbitrage borrowers. They like inefficient markets because historically that is what provided them with the opportunities." Issuers voice concerns that when pricing levels are fixed up on a screen they will forfeit flexibility and control. If an investor only chooses to look online and not speak with dealers he might fail to realize that some borrowers' levels are negotiable. Falconer, at SSB, explains: "Many borrowers have a different approach to different markets, but this can't necessarily be shown on a screen. For example, if an issuer has not done a yen trade in a while, it might be prepared to be flexible on its funding level to get a deal away in Japan." However, Sean Murphy, director and head of funding, at Citibank Credit Structures (CCS), considers it is the responsibility of issuers to ensure their levels are right. CCS speaks with WDR every day to confirm its pricing levels shown on the system. "We want what's up there to be an accurate reflection of our posting levels, but we are not committed to deal at the screen rates," Murphy says. It's up to issuers to be vigilant, checking levels and keeping them realistic. If issuers take this responsibility there is no risk." Some market participants are critical of online systems for Euro-MTNs because they believe the market should be private. Some sceptics consider information about structured notes and the pricing of private transactions should be confidential. WDR's Eddy, thinks this is an unrealistic and outdated view. He says: "I don't agree that the market is private any more. With the various information systems, databases and media devoted to the market, very few trades are not seen these days. It's very difficult to keep trades a secret now." WDR is surging ahead with the next phase of its system. This includes ChatLite, an interactive page which allows dealers to chat to investors and issuers in real time on the web. This can also be used as a proxy order form for clients. The system is also being updated to include more swaps prices and mark-to-market evaluations, as well as dealers' commentary and trading analysis. Online trading is suited to homogenous, regulated securities. Systems only show levels for fixed and floating vanilla issues. As a result, many dealers consider its value will be lost in the Euro-MTN business because it cannot be used for highly-structured notes. Over three-quarters of the total $201.69 billion-worth of non-syndicated issuance, traded between March 1 1999 and March 1 2000, was plain vanilla, according to MTNWare. This is for trades of less than $250 million and with a term greater than 364 days, excluding self-led deals and issues off financial repackaged facilities. But dealers report that the structured market is growing. And this is often where the most value is found for banks. Falconer, at SSB, is sceptical that accurate pricing for such notes can be done online. He says: I'm sure many types of securities can be traded on the web, but for highly-structured MTNs I question how quickly it can happen. I believe the success of e-trading will be limited to vanilla products." Cogoi, at BPG, disagrees. He thinks structured notes are becoming more regular and could be traded on the web. He says: "Its a matter of volumes. The more you sell and volumes increase then patterns are seen and dealers recognise structures. It's very rare now that any structure is completely new and different. Ideas tend to repeat. Having said that, there are parts of the market that are highly tailor-made." And John Key, head of e-commerce in debt markets, at Merrill Lynch, is optimistic of what can be achieved. He says: "Structured transactions by their nature are tailor-made and a machine will not easily replace the work of the dealer. But that is not to say it can't be done. There are applications that allow investors to put their requirements into set parameters and the system can price the trade." Yet, for more complex trades most dealers agree that investors usually want to talk through ideas to get extra market colour. Lytle, at MSDW, says: "Short-dated vanilla MTNs are suited to this type of technology, but I don't think investors are going to be happy buying structured products on the net. For these notes, they want a dialogue and expect advice from dealers as they are usually taking a specific view on a particular market." Kreditanstalt fur Weideraufbau (KfW), issued $716.5 million-worth of structured notes in 1999, according to MTNWare. Frank Czichowski, head of capital markets, at KfW, says: "If KfW was to post general pricing levels it could be misleading. I don't think it would add transparency. For short-term vanilla trades, showing levels is advantageous and can improve transparency. But since most of KfW's MTNs are structured notes it is difficult to post realistic levels - it is a question of market conditions and risk at a particular time." But the many benefits of online trading are clear. It saves investors and traders time and banks claim it will improve market transparency and get more information to clients. Most banks' websites include a Euro-MTN page with live issuer website links, credit research and structure ideas. But WDR's system does not show secondary levels for issuers. And some sceptics argue therefore, that there is no more transparency created from such a web page than investors get from speaking to a dealer on the phone. Eventually secondary levels could be shown, as they are for vanilla Eurobond issues, but there are no plans yet to do this for Euro-MTNs. On the plus side, Cogoi at BPG, states that web systems radically make trading more efficient because they can cut out wasted time. He says: "Some issuers have commented that they don't like it, but most dealers don't have the time to discuss a difference of one or two basis points. From the bank's point of view it's very expensive to have a trader talking this over and not getting other business done." Yet many borrowers believe their needs are being overlooked as dealers concentrate on getting web systems up and running. Advocators of online trading are defensive and claim it will not replace client relationships. They argue it is a complementary method of communication, giving investors more choice. Key, at Merrill Lynch, says: "Clients want ease of access to banks. The power of the web is the power of information and the speed in which it gets it out there. In certain areas there is resistance from investors and issuers, but ultimately it's going to be part of the everyday way we do business. Within two years people will look back and wonder what all the fuss was about." Banks launching online systems must face hurdles of security and legality. Firms are dedicating a lot of time and money to ensure their systems are secure. Key, at Merrill Lynch, admits the bank sacrificed time in its log-in process to ensure tight security. And Lytle, at MSDW, agrees it is a double-edged sword. He says: "There are a variety of security issues. We have spent a lot of time making our system secure, but greater security tends to make a system more cumbersome and less user-friendly. You have to find a balance." Security concerns will be heightened further with automated trading. WDR claims click-and-trade is already possible on its Euro-CP system, although the increased complexity of MTNs renders it more difficult for this product. Yet dealers all agree that within a few years it will be a reality. And when investors are able to simply click and trade there are many more implications which will be thrown up, as Murphy, at CCS, explains. He says: "For issuers offering a wide variety of products and reliant on swaps, if an investor could simply click and trade there would be financial risk. Borrowers wouldn't know at what level they could swap the deal out. An issuer also needs to avoid the possibility of multiple execution, where he finds that his funding requirement has been filled by more than one dealer. Unless the Euromarkets become sufficiently liquid to support an allocation process, even firm Libor-based offerings will need to be executed over the phone." Market participants know that they've seen the future of the market in online trading. And whether they like it or not progress in this area is inevitable. No doubt within the year online trading will have become second nature. Although many still need reassurance that this technology is the right path for Euro-MTNs. Czichowski, at KfW, has an optimistic but cautious view. He says: "Online trading will provide access to the market for more investors, but the market is a long way off automating structured transactions. These systems are improving the amount of information, but they won't provide liquidity in themselves, you still need dealers to support the technology." Gmac was one of the most active corporate issuers in 1999. It has reservations about some aspects of the technology but sees benefit in the way it can be used to reach more investors. Cynthia Ranzilla, vice-president, at Gmac, says: "Anything that gets information to investors in a more convenient manner is a plus. The long-term value will come if dealers are able to expand their distribution network." Banks are stressing to clients that their online systems will not replace the service of dealers, but act to enhance it and make it more efficient. Eddy, at WDR, claims the technology is about giving customers greater choice. Also, he believes the bank's strategy of being more transparent and offering up extra information will make it a tough contender among the competition. He says: "Investors will be more endeared to dealers who are transparent about pricing; showing levels and giving investors the tools to price simple structures for themselves." Yet Falconer, at SSB, points out that due to the nature of the market the value of internet systems could be limited. He says: "The Euromarket is still maturing compared to the US. It needs to be more homogeneous, and levels need to be closer to those in the secondary market before online trading can really work." That said, Falconer concludes that the market has a tendency to surprise. And where technology is involved perceptions can change very rapidly. He says: "European investors' appetite for credit has grown much quicker than people expected. The market has proved itself adaptable so there is a case to be optimistic."
August 04, 2000
