Instinet Will Turn Off Fixed-Income Trading

With pressures to control costs and a slump in its primary equity-trading business bearing down hard, Instinet Group plans to shutter its electronic fixed-income brokerage business tomorrow.

The decision to close its electronic fixed-income business was revealed April 18 in Instinet's first-quarter earnings release for the quarter ended March 31, 2002. "To permit the orderly termination of customer trading, the service will operate through Friday, May 3," says the release.The closure of Instinet's fixed-income business, which had 107 employees, is part of a $120 million cost-reduction program announced in March.

As a result of closing the unit, Instinet will save about $37 million in net costs and is expected to incur a charge of $15 million to $20 million, the earnings release states. The company cited a "global economic slowdown and uneven pace of acceptance of electronic fixed-income trading platforms," as background for the decision. But one source put it more bluntly: "They didn't get enough volume." A call to Instinet was not returned by press time. Known as Instinet Fixed Income Markets (IFIM), Instinet, the largest global-agency electronic-securities broker, began developing an inter-dealer brokerage business in 1998, which commenced live trading in the spring of 2000 in both the United States and Europe, and services over 100 clients representing over 750 traders.

"They were late in the game," says Andy Nybo, senior analyst at TowerGroup, who covers electronic fixed-income trading. Nybo adds he was surprised by how quickly the firm announced the decision to shutter trading, especially since, "They were starting to see an uptick in volumes." Nybo notes that IFIM had strategic relationships in place with primary dealers that gave them incentives to trade through the electronic platform. "They were essentially creating an inter-dealer broker (IDB) in Treasuries from scratch. To do that it takes a lot of time, it takes a lot of resources, and it takes a determined mindset to stick in the game," says Nybo. The U.S. brokerage service supports trading in about 270 U.S. government-bond products including swap-based trades and 30 Federal agencies. In Europe, IFIM's e-brokerage service supports trading in about 570 Euro-denominated bond products. As recently as March 20, IFIM announced that it was expanding to offer U.S. Treasury and U.S. agency securities to European customers. What's more, Instinet invested "significant sums" in developing a fixed-income trading system. It built a global, high-speed transactional architecture based on the Java programming language using an in-house development team that had a number of technology alliances, including partnerships with Sun Microsystems, Persistence Software, Oracle Corporation, SpiritSoft Inc., Isocra Ltd., and TIBCO Finance Technology Inc. But Instinet was apparently forced to "pull the trigger" and slash costs quickly, observes Nybo, noting that Instinet's equity business is "drying up." Instinet has been plagued by lower volumes overall, a contraction in Nasdaq market share, competition from rival ECNs, such as Island and Archipelago-RediBook, and declining fees. In fixed-income, "They were going up against firmly entrenched players like eSpeed, for example," says Nybo. But, unlike purely electronic competitors -- such as eSpeed and BrokerTec -- Instinet developed a hybrid model that included voice brokers as well as a neutral, anonymous e-brokerage service. "Providing the voice-assistance was probably an attraction to the system," he says, adding that it set IFIM apart from eSpeed and BrokerTec. "The hybrid model that they advocated, providing voice-support for electronic trading, has a place," says Nybo. Instinet's exit from the market leaves Garban ICAP's ETC -- its strongest and only competitor with a hybrid, voice-electronic approach ---- remaining in the game. Among the three main fixed-income IDBs, Nybo estimates that eSpeed has 50 percent of the volume, BrokerTec, 40 percent and Garban ICAP, the remaining 10 percent. Nybo, who believes there is room for at least three or more different systems, does not expect any further consolidation among the remaining players. "Dealers want to be connected to more than one pool of liquidity, two at a minimum, and beyond that, it depends on the shop," he says. Because voice-brokerage can be viewed as a "competing option not only for liquidity purposes but also for complicated transactions," he predicts that Garban will pick up some of the Instinet's volume.