Commentary: E Bonds Level The Trading FieldToddi Gutner
An electronic revolution is sweeping the bond market--one that could be as momentous as the Internet wave that is transforming the way we trade stocks. The $13 trillion over-the-counter bond market is inefficient, with no required reporting of bids and offers. Fixed-income investors, both big and small, don't know by how much dealers are marking up bonds, so they don't know whether they're getting a good price. But now, as issuers, underwriters, and investors begin to embrace E-bond trading, all parties involved are sure to benefit.
Bond prices are affected by the trading relationships between the participants. Technology is lifting the veil that has long shrouded this clubby fixed-income world. Instead of calling around to several dealers to get a price on a bond, buyers and sellers in the most liquid markets can get real-time prices and execute trades without talking to a trader. "There is a collapsing of the distribution system and the middlemen are being squeezed out," says Jack Mahoney, a principal with Greenwich Associates, a consulting firm.
HOME TRADES. In mid-April, Ford Motor Credit Co. became the first company to sell commercial paper directly to institutional investors over the Internet. It's likely that General Motors Acceptance Corp. and Chrysler Financial Cos. will follow suit. Some municipalities are also issuing their debt directly to customers online.
The result? Lower transaction costs for institutions and individuals. Take TradeWeb LLC, an Internet-based electronic-trading system that allows institutional investors to trade Treasuries with top brokerage firms. It recently saved one customer nearly $1,000 on $25 million worth of bonds that it was selling, says TradeWeb President James W. Toffey. That may not sound like much of a savings, but consider that $200 billion worth of Treasuries are traded daily. TradeWeb, which started in early 1998, reports a daily trading volume of $2.5 billion, double what it was in January. "Dealers are forced to post more competitive prices because of the transparency, and that creates a tighter market," says Robert S. Kapito, vice-chairman of Blackrock, which manages $80 billion in fixed-income assets.
TradeWeb is just one of the nearly 30 institutional E-bond trading systems that have popped up over the past few years. On June 24, BrokerTec set up shop. It's an online interdealer broker backed by seven large brokerage firms, including Goldman, Sachs & Co and Merrill Lynch & Co. "Any institution that doesn't have Internet access as part of its fixed-income strategy will be missing a large chunk of business in the future," says Andy Nybo, research director at the Bond Market Assn.
NO STOPPING 'EM. A recent Greenwich Associates survey of the 500 biggest Treasury investors reports that 21% trade Treasuries electronically. That number is expected to jump to 50% in the next year.
While most of the changes are taking place on the institutional side, the retail market is also making headway. In the past year, E*Trade Group Inc. and Discover Brokerage Direct have made bond trading available. Cost savings vary, but E*Trade's markups of one half to three-quarters of a percentage point are significantly less than the 1% to 3% for a discount or full-service broker. Since last October's launch of TreasuryDirect's electronic access, which allows the purchase of U.S. government debt via the Bureau of the Public Debt Web site (www.publicdebt.treas.gov), 40% of Treasury purchases are done electronically.
It's unlikely we will ever have the same price transparency and liquidity in bond trading that we have in stock trading. There are 11,000 individual U.S. stocks, as opposed to 4.5 million individual bond issues--ranging from huge treasuries to tiny municipalities. And the vast majority don't trade regularly. Still, E-bond trading can't do anything but help the world's largest financial market.