Online Money Trading Takes Off

And pricing power shifts from the banks to the customer

Caterpillar Inc. (CAT ) used to exchange billions of dollars worth of currencies over the phone each year. When the global heavy-equipment company converted money, its finance staffers called bank trading desks for quotes and placed their orders. Minutes passed before a deal was consummated--too slow in the quicksilver foreign-exchange market. Often by the time a trade went through, the best price was gone.

No more. As of Aug. 13, Caterpillar, which generates half of its $20 billion in annual sales outside the U.S., does those deals online, using FXtrades, a unit of upstart Currenex Inc., a Menlo Park (Ca.)-based online currency exchange. Caterpillar can now compare prices and place an order immediately. "A minute is a long time when you're trading currencies," says Currenex President Lori Mirek.

At long last, companies and institutional investors, which together initiate about 30% of the daily $1.5 trillion in global forex trading, are realizing that the old way of doing currency transactions was only a boon to banks. While global corporations worked the phones, the bank dealers bought and sold electronically, allowing them to profit from quick price shifts customers didn't see. Now the Internet is shifting pricing power to customers, as it has with equity trading, with big implications for banks' revenues and profits.

Companies are wising up fast. TowerGroup, a consultancy that analyzes technology use in financial services, predicts that companies and institutional investors will do up to 75% of their forex trades online by the end of 2003, compared with about 10% last year. In a few years, Mirek contends, only the biggest, most complex trades--those of $50 million or more that need to be broken up and placed discreetly to avoid distorting the market--will be done via phone. Competition, already intense, will sharpen; margins will narrow; and longstanding relationships between banks and their corporate clients will weaken.

The forex market has been much slower than the equities world to join the Internet Age. Banks say that's because devising a new system to connect so many players is technically challenging. But some chief financial officers suspect the banks were dragging their feet because they make such big profits--an estimated $10 billion among them last year--from the status quo. More than 25% of the banking profits of Deutsche Bank (DTBKY ) and Citigroup (C ) came from forex last year. "The interbank market was automated," says Tom Buschman, treasury development manager for Royal/Dutch Shell's treasury department. "But companies and investors have mainly had to continue using the voice market."

Interbank trading is done through automated order-matching systems, such as Reuters Dealing 2002-2 and Electronic Broking Service, established in the early 1990s. They automatically check counterparties' credit lines and send information needed for clearing and settlement to back offices.

TRANSPARENCY BOOST. The Internet will give customers similar advantages. The first online trading venue was mutual-fund giant State Street Bank's FX Connect, a private network established five years ago to allow its institutional clients--pension and mutual funds--to trade with it electronically. Last year, State Street opened the system to other banks.

But it was the arrival of Currenex in 1999 that forced the banks to take no-tice. Currenex was founded by Mirek, former general manager of America Online's (AOL ) B2B e-commerce division, with $22 million in venture-capital financing. It links some 40 corporate clients, including MasterCard, the Henkel Group, Ericsson (ERICY ), and Royal/Dutch Shell Group (RD )--which is also an investor--with more than 40 member banks, including Britain's Barclays PLC (BCS ), Germany's HypoVereinsbank, and the Netherlands' ABN Amro (ABN ). As with State Street's system, clients view quotes and enter orders online. Besides improving transparency, online trading reduces the chance of costly blunders, says Buschman. "It's easy to confuse 17 and 70 when you're talking on the phone."

Mirek won't say how much business Currenex has attracted. But strategists at the big forex-trading banks doubt it is more than $1 billion a day. Still, they can't ignore a rival with customers like MasterCard and Ericsson. The pressure increased when State Street opened its system to other clients and banks. Meanwhile, other trading ventures, such as Warren (N.J.)-based GAIN Capital, are targeting smaller companies, hedge funds, and wealthy private investors.

Now institutions that lacked the global presence of the top forex players are creating their own online exchanges. Goldman, Sachs & Co., for example, jumped from sixth place last year to third place this year in forex trading volume, according to the Euromoney Annual FX Poll, after it added foreign exchange to its electronic trading platform, Web.ET, in October 1999. "Being big is no longer the key to success," says Zar Amrolia, Goldman's global head of e-commerce and FX Sales.

The old-line forex powers aren't taking this lying down. In June, 2001, 14 of them, which collectively handle 25% of forex trading, got together and launched FX Alliance LLC. It now links 50 banks. That same month, the three biggest forex traders--Citibank, J.P. Morgan Chase, and Deutsche Bank--parried by joining forces with Reuters Group PLC to form Atriax, which now links some 70 banks, accounting for half the market.

The bet in the forex market is that the two new arrivals will quickly dominate. "From a corporate perspective, proprietary single-bank platforms will have a very limited shelf life," says Ted Orban, international treasury director at Motorola Inc. "And there is only room in the market for two or three multibank portals."

That's bittersweet news for the banks. Analysts say that as online trading volumes grow, margins--already a wafer-thin 0.02% in the huge euro-dollar, dollar-yen, and yen-euro markets--will narrow, driving down trading revenues. Profits, however, may not fall in tandem, Fxall CEO Phil Weisberg argues, because Internet trading "is cheaper and more efficient."

One likely result: Banks will shift staff from phone orders to marketing, which they'll need more of now that clients can easily find the best deal. For years, forex traders have been powers in the financial world. Now, the Internet is bringing them down to size.

By David Fairlamb in Frankfurt

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