Though Internet bond-trading platforms continue to evolve, investors in asset-backed securities (and other less commodity-like markets) remain skeptical, primarily from liquidity concerns associated with multiple, fragmented marketplaces.
"The system really only works well to the extent that you have a wide audience, or that a wide audience sees your bonds," said Michelle Russell, a vice president and project manager at Hyperion Capital Management.
"To the extent that there exists many, many different platforms to do the same function, I think they'll all suffer, whereas one more consolidated effort will probably fair better," she said.
One industry source said there are currently as many as 80 bond-trading platforms, and, in response to investors demanding a comprehensive marketplace, the companies are rapidly expanding their product bases, to "offer everything to everyone."
In essence, what was initially a race to capture certain markets has become a race to capture the entire bond market, via partnerships and consolidation.
Currently, companies like Visible Markets, Pedestal, Bond Connect, and BondBook are among competitors with bond trading platforms either already trading asset-backed securities or moving in that direction, industry sources said.
Additionally, a yet unnamed company formed by Bear, Stearns & Co., Credit Suisse First Boston, Lehman Brothers and Salomon Smith Barney has begun development of an online secondary market platform for trading ABS, MBS and agency fixed-income product, according to Securities Industry News, a sister publication to Asset Sales Report.
Visible Markets, with a platform that allows for ABS, mortgage-backed securities, commercial mortgage-backed securities and investment-grade corporates, has already signed on 120 investment institutions, the company said.
Since launch, the company has seen $4.5 billion in auction postings, 20% of that in asset-backed securities.
"We're currently closing approximately 10% of the auctions," said Bill Martin, vice president in marketing at Visible Markets.
Pedestal, on the other hand, has cornered the more commodity-like whole-loan and TBA (to be announced) MBS products. According to Pedestal's web site, the platform has signed 1,800 users, 40% of which are buyers and 60% are sellers.
The Counterparty Issue
One issue raised by investors critiquing the current Internet platforms is that a seller is often looking to buy back a hedge as part of the transaction.
"When you have a bond that you own and you want to sell it, you often want to buy back Treasury [bonds], or vice-versa, or whatever your hedge is," said Hyperion's Russell. "The Internet systems don't facilitate that."
Further, investors are reluctant to trade if they are not confident in the financial strength of the counterparty. Many of the traditional brokerages are investment banks rated above investment grade, which is an important aspect to a trade, Russell said.
"Who are you going to depend on if the trade falls apart?" she asked.
However, as part of the evolution towards a liquid, online fixed-income market, the Internet platforms are addressing these issues.
For example, via a partnership with eSpeed, Visible Markets is working to add Treasurys to its product line, Martin said, though he was unable to put a timeline on the introduction of this feature. Visible Markets uses, as a clearing house, Nation Financial Services Corp. (NFSC), a subsidary of Fidelity Investments with a net capital of $1 billion at its disposal.
Virtually all of the platforms are courting investment banks, as both equity partners and liquidity providers.
On the flip side, the banks seem to be partnering with multiple platforms, hedging their bets for consolidation.
For example, State Street Bank is in a partnership with both Bond Connect and Visible Markets. While Salomon Smith Barney is a partner to BondBook, the firm is also a cornerstone of the yet-to-be named consortium with Bear Stearns, CSFB, and Lehman Brothers.
Bondbook is also partnered with Goldman Sachs, Merrill Lynch, Morgan Stanley Dean Witter, and Deutsche Bank. Deutsche Bank is also partner with Pedestal.
"To the extent that there's multiple trading systems for a single product, you couldn't simultaneously put your bond out for bid on more than one system, because what if you got hit twice?" asked Hyperion's Russell.