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Broking Smarter, Cheaper, Faster

There's no shortage of competitors duking it out for control of the interdealer derivatives brokerage market. On-line exchanges such as eSpeed, interdealer consortiums such as London-based EBS and independent electronic brokers such as Blackbird.net have all announced plans to capture a part of the business now dominated by traditional voice brokers.

The latest competitors to enter the fray are Jeff Larsen and Neil Chriss, two derivatives pioneers who have teamed up to form ICor Brokerage, a New York-based company they hope will revolutionize the interbank derivatives market when it launches in October. The firm's first goal: to become a sophisticated, high-quality electronic interdealer broker of foreign exchange, fixed-income and equity derivatives.

Early last year, when Chriss was a portfolio manager at Goldman Sachs Asset Management, he toyed with the idea of creating an interdealer exchange for volatility derivative products. After hacking out a skeletal business plan, Chriss realized that the business he envisioned was bigger than he had first thought. "I couldn't be the CEO of something this big,” he says. So he called his friend Jeff Larsen, who had recently left his position as head of international capital markets at Chase—a 480-person group with revenues approaching $500 million.

Officially formed January 5, 2000, the company has secured financing in the "high seven figures” and now employs 26 people. It plans to offer a beta version in September and go live in the foreign exchange markets on October 1, in interest rates in November and equities in December.

ICor says its principal advantage over traditional voice brokers will be its low-cost structure and commitment to client service. Because the firm is not saddled with an existing trading staff and outdated technology, it says it can afford to cut standard commission costs by more than 50 percent. "If we capture just over 4 percent of the voice broker market,” says Chriss, "we'll be extremely profitable in 2001.”

"Brokers felt they provided more sophisticated deal matching. Our system can do this automatically.”
—Neil Chriss

Users will see live bids and offers organized by product groups. Within foreign exchange, for example, users will see puts, calls, risk reversals and strangles, and be able to sort offerings with different currency tabs. In addition, users will be able to enter "subject” prices that can be traded against only after a final approval by the trader.

ICor also plans to distinguish itself from the pack by offering something it calls "agent-mediated brokerage,” a technology that can actively recognize the properties of various derivatives products. "Nowadays, when two people are near each other but not exact, a matching system can't make a trade happen,” explains Chriss. "But in our system, two traders who are close but not exact will be alerted, just as a voice broker would do. The system recognizes that a trader is often interested in a particular exposure as opposed to a particular position. In so doing, the particular parameters of the instrument the trader's trading do not have to be precise.” In other words, the system examines bids and offers and matches products that are close enough to one another to be attractive to both parties. For instance, someone looking for a one-year straddle may be matched with a person selling a nine-month straddle. "As long as the price is right,” says Chriss, "other considerations, like duration, aren't as important.”

"One of the reasons brokers felt that certain derivatives products were never in danger of being brokered electronically was because they provided more sophisticated deal matching,” says Chriss. "If I put up a bid for a 50-delta one-year option, I would be extremely upset if my broker neglected to tell me that someone else was offering a 45 one-year option. If he can't make a trade happen there, he shouldn't be a broker. Our system can do this automatically.”

ICor also plans to offer a number of functions to streamline dealing confirmations and increase back-office functionality. In its final form, data will be able to flow directly from ICor to a dealer's mark-to-market, risk management, legal and credit systems.

ICor is also hoping the system will help dealers concerned about profitability. "You become more efficient with faster pricing modules, better risk management, tighter pricing and fewer errors,” says Larsen. "If you don't have to rekey, which is a huge part of the error rate, you can do more deals per trader. If you can keep revenue the same and cut personnel and processing costs, it's win-win.”

Targeting European Equities

Participants in European equity derivatives markets will soon have a web site of their very own. Last month, Kappa

Financial Services, a voice broker specializing in German and U.K. equity derivatives markets, announced plans to launch a web site—TradeKap.com—that hopes to offer quicker and cheaper broking than the competition.

"Currently, there are close to 22 voice brokers vying for equity derivatives business in Europe,” explains Simon Roberts, a former equity derivatives trader and broker. "It is somewhat chaotic trying to follow what each of them is trying to peddle. We are not trying to replace all these brokers—some will inevitably survive for the added ‘color' that they provide—but we are trying to make the entire delivery process more organized and more efficient.”

TradeKap.com offers something like a Reuters Dealer messaging system, but with individual over-the-counter equity derivatives interests visible to multiple counterparties simultaneously on an anonymous basis. A counterparty that wants to buy a tailored option on a basket of five European stocks, for example, would post the details of the request on the platform—strike, maturity, put or call, and size. Any interested dealer using the system could come back with a volatility offer and proposed delta hedge or other details. It's a bit like making hundreds of outgoing calls yourself or having a broker do that for you—only all of the details of the trade are laid out on the screen instead of shouted down a hoot-and-holler broker line.

The system exchanges counterparty information only when two parties become interested in dealing and agree on various details of the proposed trade. If the deal is an exchange-lookalike trade, it can be crossed on the trading floor of the appropriate exchange with an agreed delta hedge as well. If the deal is an OTC option, then it waits for both sides to sort out the credit approvals.

TradeKap.com has also come up with a new pricing system. Once a subscriber pays an upfront fee and subscribes to the TradeKap portal on a monthly basis, all trades that one does on the system carry no further brokerage charges. Jason Batten, the firm's head of booking, claims that this will offer customers a "unique and aggressive pricing policy that will provide huge savings to market users.”

The system will specialize in OTC contracts and exchange-lookalikes, which mimic existing listed contracts but may be for larger size, broken dates or combination trades such as covered calls. Roberts hopes his portal will be used to scope out interest for deals that are too large to execute directly on exchange floors.

Twenty investment banks are now taking part in a test phase. By the end of August, Roberts hopes to go live with between 150 and 300 subscribers, offering options on the DAX, STOXX and FTSE, and individual contracts on the largest British, German and French corporations.

The system has already won praise from Paul Anderson, a vice president and senior trader at Citibank Frankfurt, who says the system "reduces the amount of time involved in following the various markets,” and that "liquidity is already as good as—if not better—than that offered by voice brokers.”

Kappa does not intend to reduce its small staff of voice brokers—at least for now. While Roberts thinks the majority of his firm's vanilla derivatives will soon be trading solely through the electronic platform, he still thinks voice brokers will have a role in more complex exotic transactions. It is also possible, of course, that voice brokers might step in to help consummate a negotiation on the electronic system that is close to being complete, but needs a little extra push.

Depending on TradeKap's success in Europe, the firm may also establish other similar platforms in the United States and Asia. "Established brokers would have to turn their shops upside down to develop this kind of platform,” says Roberts. "For us, this is quite an easy, natural progression.”

One-Stop Treasury Shopping

"Hey Bill, this is Larry. How's the British pound today?”
"Been all over the place, Larry. We've had a range of 1.4830 to 1.5165. What are you looking to do?”
"I need to sell 2 million pounds one month forward outright. You want to show me that price?”
"Sure, let me see where the spot is first...1.4865 is the best I can pay at the moment, Larry—this stuff is pretty weak.”
"OK, I better do that with you then. Can you call me back with the forward point adjustment when you have the chance?”

Not long ago, that might have been the conversation between a trusting corporate treasurer from middle America and his New York foreign exchange salesperson. If the salesperson had actually visited Larry's offices, he might know that Larry did not have a real-time Reuters or Bloomberg machine and was too shortstaffed to make multiple phone calls simultaneously. Even the most puritanical salesperson (with a bonus always hanging in the balance) would deem it his duty to "take a nice spread on the trade.” If the pound had just rallied back to 1.4940, so what? 1.4865 was still in the day's range.

With the advent of the Internet, the days of egregious price-gouging are over, and both the banks and the corporate treasurers realize it. Instead, a number of portals set up by individual banks, bank consortiums and Internet startups have popped up to improve transparency and competitiveness in the capital markets.

One of the most ambitious is CFOWeb.com, a subsidiary of Mountain View, Calif.-based software company Integral. CFOWeb.com is trying to tackle not only corporate access to the foreign exchange markets, but other over-the-counter products on which a corporate treasurer or money manager might typically be focused: interest rate deposits, swaps, swaptions, and currency and currency options. The company's professed goal is to offer a one-stop shopping portal for all non-exchange traded treasury financial needs—with a variety of dealers competing to show prices on a playing field far more level than in the past.

CFOWeb flipped the switch on its new web site on June 27, with a variety of financial institutions lined up to participate. Inaugural providers include Bank of America, AIG, ABN Amro, Standard Chartered and BNP Paribas. Credit Agricole Indosuez and Dresdner Kleinwort Benson have since joined this group. Although mega-names such as Citigroup, Chase or Deutsche Bank are notably absent, CFOWeb clearly lined up some powerful support.

In a nutshell, here's how CFOWeb works.

Anyone can apply and receive a password for access to the site. But to trade on CFOWeb.com and to use its portfolio features, a corporate treasurer must also have a pre-established dealing relationship with at least one of CFOWeb's participating financial institutions. If that treasurer wants to be introduced to some of the other banks his or her institution is not currently dealing with, CFOWeb can make an introduction, but this is up to the individual customer. Of course, the more banks showing the corporate treasurer prices, the more useful and competitive the site should become.

Let's assume the treasurer needs to sell 5 million euros to hedge next quarter's anticipated foreign revenue stream. The treasurer would just tap in the request to sell euros forward outright for three months, and the amount of time within which a response is needed—perhaps 30 seconds or a minute or two. Each of the banks chosen for a quote would then scramble to show their best all-in respective bids. The banks set their own respective time clocks for how long the price is good for. There is also a chat function if one side or the other cares to haggle or work out details.

If the treasurer deals with one bank, each of the other institutions automatically gets back a "nothing done” response. If the treasurer simply lets the clock run down on all the bids received, all the banks will similarly receive a "nothing done” message. But when one bank does participate, that bank verifies the trade, and the deal flows automatically to the customer's CFOWeb portfolio and to the dealing bank's back office.

Once the deal is booked into the portfolio, CFOWeb.com then offers a number of free risk reports showing P&L, exposure to price movements and volatility changes. There is also a useful audit trail showing all prices the customer was shown as well as the prices accepted.

Sound pretty nifty and Charles Schwab-like? Well, it's not bad, but upon close examination, one can imagine a few logistical problems—rough edges, that could prove mission-critical.

First, many individual bank dealing portals have default real-time prices that pop up for a given contract or option when a request comes in. In the case of foreign exchange, this is often driven by the inside price shown by the interdealer EBS (Electronic Broking Service) terminal. In the case of options, it may be driven by the quoting bank's latest volatility mark-to-markets. Once the quote request and default price pops up, the dealer or salesperson can decide whether to simply show the default price or change that price. But with one click or keystroke, the person can do either and send the correct price on its way.

CFOWeb.com does not appear to have any real-time default price feed for the dealer or the customer to start off with. While individual banks may design such interfaces on their end, CFOWeb might stand at a disadvantage compared with a GFInet.com, for example, where forward points and volatility levels stream automatically into a customer's pricing tool kit even before a dealing price is requested.

Second, what happens when a somewhat more complicated deal is being requested rather than a simple foreign exchange forward? CFOWeb.com claims that currency options, for example, are to be quoted on its system in terms of volatility. But once a volatility bid or offer is accepted, who sets the spot, forward points and risk-free interest rate to calculate the actual dollars-and-cents price? For the moment, CFOWeb hasn't fully mastered all of these details, and a follow-up phone call might be required. The trade price would then need to be entered into the portfolio manually. That obviously puts claims about the system's automatic straight-through processing seriously in question.

Perhaps these are just growing pains in the early days of a nice neutral portal's growth, but perhaps not. One gets the sense that a group of programmers with some treasury background designed this system without fully considering all of the small items that must eventually be agreed upon when closing a derivatives deal—beyond just a quoted volatility.

Let's go one step further and ask the question, Why do more than 90 percent of banks globally have a copy of software package Fenics on their desks even if they have other in-house quoting and booking systems for currency options?

The answer is that the typical corporate treasurer often does not want a price in just one option, but wants the all-in premium cost on a strip of options expiring every month (or quarter)—often extending out several years. In other instances, the treasurer may want to do a collared transaction, asking for a strip of call options struck some percentage above the forward rates, to be balanced by puts the treasurer is willing to sell in order to create a zero-cost collar. In this instance, the treasurer asks for the list of strikes that must be sold. In other cases, the corporate may want to buy one option and finance it with the sale of two others—a so-called three-way transaction. These are not odd requests, but simply the normal way more than half of the options business gets transacted today.

CFOWeb is not a bad first cut, but the designers have underestimated the importance of small bells and whistles.

Fenics' pricing spreadsheets allow traders and salespeople to calculate such prices and keep all-in premium calculations refreshed relatively easily as spot markets jiggle around. CFOWeb.com, in its current design, comes nowhere close. With CFOWeb's ability to transact just one option at a time, one must wonder if the portal is not a nice idea in concept, but flawed and overly simplistic in its abilities to service actual corporate trading habits. It may be more natural to allow competing banks to fill in a Fenics-like spreadsheet posted over the Internet.

What about CFOWeb's free risk management? CFOWeb can break down a swap or portfolio of swaps into a "value of an 01” sensitivity and an implied zero curve. It can also run risk reports showing the P&L impact of a jump in a currency spot rate or volatility curve. Unfortunately, the formatting of the reports at present is less than useful. You can see the impact of a one-off change in an input parameter, but there is no overall spot sensitivity ladder allowing parameters to be permuted multiple times across a range of prices, volatility levels or days to expiry. Similarly, convexity and gamma measurements are all there in theory, but the calculations and formats of the reports are vintage 1984, not 2000.

Although the trading and risk management sections are CFOWeb's raison d'etre, its free news and research areas are actually the most well-designed and useful parts of the whole system—at least for now.

Under the myCFO section of the web site (not to be confused with the myCFO.com personal asset management web site) one can access news headlines and stories from around the world. Bloomberg, the Washington Post, the Wall Street Journal, Reuters—they are all there, together with more arcane sources such as the Evening Standard and the Bangkok Post. And the list goes on and on. Better yet, you can personalize your news page to include certain news sources or market segments. You can also search all of these respective news sources simultaneously.

Don't know why the South African rand plummeted overnight? The myCFO tab of CFOWeb.com might be your first logical stopping point.

Each of the supporting banks also places a certain amount of their individual research up on the CFOWeb site free of charge. You won't find every piece of research produced by a given institution, but you will find some, and the consolidated nature of this offering holds great time-saving appeal.

Is CFOWeb the next generation of how capital market transactions are going to be transacted? Don't bet on it. CFOWeb is not a bad first cut, but the designers have underestimated the importance of small bells and whistles, just as they may have overestimated the importance of a neutral multi-bank, multi-product dealing platform.

CFOWeb's revenue model, which relies on fees paid by banks to participate, may also be flawed. Integral officials admit that many of their supporting banks are also launching their own standalone Internet trading platforms and participating in other portal efforts. If other competing efforts take off, CFOWeb.com could find its current support quickly undermined.

—Barclay T. Leib

A Stealth FX Platform, Reborn

If CFOWeb.com has been aggressive in its recent marketing of itself, Currenex, another dot.com occupying a similar space, remains far more of a stealth player.

A real-time currency dealing platform, Currenex quietly began operations in late 1999, without even a press release. In April, six months later, the firm announced that it had facilitated more than $5 billion in cash and forward foreign exchange transactions over the Internet during its fourth quarter. This year, CEO Lori Mirek is hopeful that the Currenex volume figures will move above $1 trillion.

Currenex allows corporate treasury officials to execute currency spot and forward transactions directly with member banks. Mirek says Currenex now has more than 20 global banks supporting it, but she's not revealing which ones. However, she's happy to cite positive reviews from three large corporate clients—Mastercard, Intel and Electronic Arts—all using the system. Stephen Piccininni, vice president of treasury at Mastercard International, for example, says his firm has done several studies showing improved execution performance since his firm elected to use Currenex for 97 percent of its foreign exchange needs. Mastercard has now used the system for more than four years.

Four years?

Yes, that's right. You see, Currenex is actually a retooled Internet version of FX Fox, a system that for a number of years served a handful of corporate foreign exchange clients over a virtual private network. Mirek, a former AOL and Netscape senior executive with an entrepreneurial itch, bought the rights to the system in 1999—seeing in foreign exchange a perfect fungible product with fragmented and inefficient delivery. She clearly hopes to be to foreign exchange what Jeff Bezos is to retail book selling.

So far, Currenex seems to be making fewer general design mistakes in its effort than its CFOWeb rival. In addition to a real-time news ticker and slightly delayed Reuters price indications streaming in the background, there is a button to ask for a two-way quote, should a customer so desire. Then, as quotes are received, the system automatically highlights the best price received—all nice little features that CFOWeb lacks. The system provides details on all of the banks logged on to the system at any one time, and allows customers and banks to chat outside of an actual quote request.

The system also gives participating dealers far more detailed information than CFOWeb. Currenex lets all participating banks know by how much they won or lost a deal. It also breaks forward prices down into spot and forward components, so both spot and forward traders can separately be held accountable for failing to capture business. The system also stores all data between a bank and any given client, allowing both to check relative dealing performance over time.

Later this year, Currenex plans to roll out currency options dealing, and, unlike CFOWeb, promises to offer option combinations such as straddles, strangles, risk-reversals, put and call spreads, as well as simple exotic options. Options will be priced in either volatility terms or as a percentage of the underlying notional amount—in accordance with a client's specific request.

Currenex charges what it calls "a modest per-transaction fee” to both dealers and end-users. In theory, this could be a better revenue model than CFOWeb, whose cost burden falls solely on the bank's side but is not directly tied to how much business a bank or customer transacts. After all, corporates should be willing to pay something to get equal-footed price access and transparency.

CFOWeb.com currently beats Currenex hands-down in just two areas—risk management and access to bank research and wide-ranging news. Although Currenex does offer an audit trail of requested quotes and trades, it is not planning to build its own sensitivity analysis platform. Instead, it is negotiating to provide seamless interfaces between itself and other sophisticated risk management systems. "Why try to reinvent the wheel when most corporates out there already have a risk management platform they are comfortable with?” says Jeff Walker, vice president of product development. "We just want to improve the execution process and let this dovetail into other systems people are already using.”

Behind the scenes there may be an embarrassingly large overlap between Currenex bank supporters and those of CFOWeb. Currenex's Mirek admits that some banks are trying out both systems. This is because currency dealers appear to have split themselves into three groups: those willing to try out all of these new portals; those disdainful of any competitive dealing platform altogether; and those large-capitalization behemoths—such as UBS Warburg and Credit Suisse First Boston—that are simply waiting for their own FXall.com consortium platform (see e-Notes, July 2000) to be released.

FXall.com is indeed likely to be Currenex's greatest competitor. Currenex needs to grab as many new clients and bank participants right now simply to avoid getting run over when FXall finally arrives. By keeping its platform user-friendly and easy-to-use so far, Currenex appears to be making some headway in this mission.

But then again, Is Jeff Bezos at Amazon making any money yet?

—Barclay T. Leib


Fenics software announced that 1,400 new subscribers priced more than 90,000 options in the first two weeks after the site's launch on July 10. The site's basic silver service is free, but the more sophisticated gold and platinum services cost up to $500 per month per user.

The company recently announced strategic partnerships with ABN Amro, Dresdner Kleinwort Benson, Lehman Brothers, Bank of America, Credit Suisse First Boston, Societe Generale and UBS Warburg to provide proprietary information through its new on-line service. It also announced an agreement with International Financing Review, part of Thomson Financial, to provide the site's foreign exchange and economic news content later this year.

The company has begun selling Futrak 2000, its FAS 133-compliant derivatives trading and risk management software for free as part of a subscription pricing offering. A basic support level, offered for $600 per month, supports 30 usable open trade slots. Additional trade slots are available in blocks of 10 at a cost of $100 per month.

Risk Management Solutions announced the release of Climetrix, an Internet-based series of data and tools for the weather market. Users have access to a suite of modeling tools that simulate thousands of years of potential weather behavior to help analyze and track the risks to individual contracts and portfolios. The site includes a database of cleaned and enhanced historical weather data developed by Earth Satellite Corp., with 50 years of data for the 200 most commonly used weather stations associated with weather contracts.

The credit derivatives trading platform announced it would offer emerging-market credit default swaps. The company, which previously focused on investment-grade corporate default market, plans to expand into Latin American and Eastern European sovereigns and corporates. The firm recently received regulatory approval from the Securities and Futures Authority. It also announced a strategic partnership with Credit Suisse First Boston, involving cash contributions and commitments to add liquidity to the platform.