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Andrew Rafalaf
Andrew Rafalaf
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The Death of the Inter-Dealer Broker?

With the coming of online wholesale debt markets, the future of Cantor, Liberty and Garban's brokers is on shaky ground.

Ding, dong rings the death knell for the inter-dealer broker. While the bell emanates from some far off place over the horizon, reckoning time, as they say, is nearing. The financial industry has acclimated-some more, some less-to the ways in which the Web has redefined the retail investment industry, but the institutional folks have just woken up to the possibilities that electronic commerce brings: broader, deeper markets with greater liquidity.

Inter-dealer brokers have always served a fundamental need in the fixed-income trading arena. Dealers have traditionally relied on these brokers to farm out a large bond trade so that competing dealers aren't privy to who is trying to off-load that amount of bonds onto the market. If the dealers had to go directly out to the market, their competitors would short whatever bonds they are trying to sell, and drive down the price.

The dealers, who need to provide the best customer service they can to their own clients, are looking to Web-based systems to offer greater price transparency and quicker execution. With the emergence of automated matching engines that retain the secrecy of their users and hunt out best prices, who needs a broker when a system can do it more quickly and efficiently?

Cantor Fitzgerald, proving itself more prescient than its competitors, identified the benefits of e-commerce early on and rolled out a product and division last year called eSpeed. eSpeed is ultimately an electronic alternative to the inter-dealer broker as it offers Cantor's banking clients the option of offloading large bond transactions online. The goal of any interdealer broker market is volume and transparency, and that is exactly what eSpeed has brought to its clients via the Web. Whereas eSpeed designed an entirely new system from the ground-up, Garban and Tullet & Tokyo Liberty, the two other major inter-dealer brokers, have essentially married Web front-ends to the electronic systems that their in-house brokers have used to trade for years, creating ETC and Liberty Direct, respectively.

An even greater problem facing the brokers is a huge cloud called BrokerTec, a consortium of banks that is working to create its own online, wholesale marketplace. Once again, the Internet provides for the emergence of new intermediaries, while supplanting the old. BrokerTec wouldn't be so threatening if it wasn't backed by many of the very biggest dealers, the very dealers that have fed Cantor, Garban and Liberty for years. BrokerTec threatens to cut the inter-dealer firms completely out of the equation.

"Will this kill all the independents (inter-dealer brokers)?" questions Bob Iati, TowerGroup analyst, referring to BrokerTec and industry consortia. "The answer is, quite possibly, yes."

Bye-Bye Broker?Brokers are most definitely re-evaluating their value proposition in this rapidly changing environment. While the firms duke it out over which system will succeed, the brokers themselves need to prove that they can provide more than the systems. Electronic systems naturally mean fewer brokers, and those that remain need to change the way in which they do their jobs, and fast.

"You need far fewer salesman and they become more account management," says Greg Smith, an analyst at Chase H&Q. "This is still five years down the road, but it's definitely coming."

Chris Ferreri, head of IT strategy for Garban, acknowledges the fear emanating throughout the broker community, a growing sense of doom. "My first answer to them is that I'm not sure how electronic trading impacts the broker a year from now," Ferreri admits. "I can tell you that we'll support voice brokering as long as the commission structure supports it. If a client is willing to pay a commission to talk to a voice broker, we'll find a way to keep that voice broker on the phone. If clients are only looking for the cheapest way to transact, I'm not sure if the broker will stay around."

Ferreri, himself, is a good example of the adapt or die mentality. A broker for over 15 years at Garban-most recently managing the firm's yield curve swap trading desk-he bid for and assumed the firm's chief technology position. As someone with a degree in electronic engineering, this was a decidedly easy move, but others need to consider how they can position themselves in an electronic future, how they can offer value above and beyond price transparency.

Just as the role of the retail broker has morphed from a trade facilitator into more of an advisory role, so too the inter-dealer broker must look beyond the transactional services. Hal Hinkle, president and CEO of BrokerTec Global, believes the salesman really needs to focus on gathering and disseminating investment information to clients in an understandable manner. The Internet has proven a great source for an infinite amount of financial data, but the broker's clients are left surfing, somewhat quizzically, through many disconnected Web sites. The broker, Hinkle believes, will have to be an aggregator of that information.

"Because of the Web, information is more democratically available and more transparent," he points out. "The consequence of this is that managing that information becomes more and more important. As a customer, if my salesperson really knows the available Web sites inside and out, and can help set it up for me so that I get the information when I need it, that's the salesperson that will survive. In essence, they become real-time electronic desktop publishers."

Interestingly, Ferreri believes that the brokers that cover the active traders at the big dealers are the ones that have a better chance of surviving. "For example, the broker covering the five-year trader at Merrill Lynch has a better chance of being around than the broker covering a proprietary trader at the same firm," he details. "Why? The proprietary trader may come in once a week ... when he wants to sell, he'll just press a button."

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