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Chuck Epstein
Chuck Epstein
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Electronic Bond Trading Systems Pass Critical Mass

The numbers tell the story: bond traders, long considered the most conservative of financial market participants, are changing the way they conduct business in an increasingly electronic trading environment.

Among the newer entrants into the institutional market is LIMITrader, which went live in September 1998. Most recently, Softbank Technology Ventures and Zero Stage Capital Co. have invested an undisclosed amount in the company. Edward McGuinn, President and CEO of LIMITrader Securities, Inc., said the firm had the first system that "completely automated the trading conventions of the bond market through its one-on-one negotiation capability." McGuinn also claims the firm's network extends the automation process of online trading through the invention of "one-on-one online anonymous negotiation."

While the current number of systems is expanding, the technology behind it is not new. Dexter Senft, managing director of Lehman Brothers capital markets division, said he first saw a working bond trading system in 1983, "but the Street gave it the cold shoulder."

"The technology here is at least 15-years-old," Senft said, but what has changed is the marketplace. About 90% of Lehman's institutional clients now have access to the Internet from their offices, and about 100% from their homes, he estimated. Growing familiarity with net browsers and buying goods over the Net has also reduced qualms about the new technology and what it offers. "This is no longer a foreign concept," Senft observed.

While some traders have raised questions about the number of systems currently available and the possibility of fragmenting the markets, Senft of Lehman Brothers said there is "no such thing as one right system which is appropriate for all different types of markets and market conditions." Tradeweb, for instance, accommodates large Government trades, but that same system cannot handle low liquidity instruments, such as junk bonds.

Among the dealers who would purchase these individual systems, there is everything from total acceptance to growing familiarity. The key purchasing decision seems to be based on the needs of the firm's ultimate customer.

For instance, Vining, Sparks, an institutional fixed-income broker-dealer in Memphis, Tenn., has used the Bloomberg system since the mid-1980's to buy and sell bonds for its institutional customers. Peter Colin, managing director of information technology, said the firm is familiar with other systems, such as those from BondConnect and TradeWeb and "we expect to participate in some of the new systems, but the wave has not crested here yet" in terms of adopting new systems.

Brian Zwerner, vice president and interest rate product trader for BankAmerica, said his office makes about 10-15 trades per week with an average size of $5 million on the TradeWeb system. He has made trades as large as $25 million for the structured portfolios on his desk. The system was chosen, Zwerner said because of its inclusive pricing in off-the-run securities that are often less liquid. The decision to use the system was facilitated since it was endorsed by other dealers, Zwerner said.

Other users cite the lower back-office overhead and reduced possibility for entry errors in the trade processing. At First Tennessee Capital Markets, a large underwriter of agency bonds, Russell Knox, vice president and manager of information systems and technology, said about 50% of the firm's trade processing is automated. "That has significantly reduced our overhead expenses and number of errors. We process up to 1,000 tickers per day automatically for all out Treasuries and agency bonds," Knox said.

A regulatory threat?

While fixed-income trading systems offer new opportunities, they also fall into uncharted regulatory territory. In 1998, the SEC published proposed rules for the regulation of electronic or "alternative trading systems" (ATS) that looked at revising the regulatory framework for organized securities markets, including bonds.

In a comment letter, the Bond Market Association said it "strongly opposed integrating fixed-income trading platforms into a "national market system or any additional regulation of electronic trading systems or inter-dealer brokers as exchanges." That definition of ATS was later expanded to include debt trading systems, so the Association urged the SEC "to proceed with extreme care to ensure that its ATS Proposal will not have the effect of unintentionally impeding innovation that is beneficial to the bond markets."

As the issue now stands, the Association is pushing for an incremental regulatory approach to encourage technological innovation under the 1934 Securities Exchange Act. Market forces, not regulation, should determine this future direction, so the Association "expresses strong opposition to the imposition of equity-based national market system goals on fixed-income securities trading systems.

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