Electronic trading, year 2

Last year's Electronic Derivatives Trading for Idiots was a map to a newly discovered territory with sketchy borders. Now, in 2001, we're beginning to see the outlines of the new continent.

Last year, the established wisdom was full of millennial doom. New independent alternative trading systems were on the verge of disintermediating established financial institutions. Although banks and brokerage firms would try to fight the tides of change by developing individual trading sites, their efforts were viewed as an absurd rear-guard defense. Their chances to form consortia were considered equally hopeless because committees of competitors would never be able to form a viable trading system.

What a difference a few months makes!

Financial intermediation, we've discovered, is a tough business to crack. CFOWeb and other ambitious alternative trading systems have recently abandoned their plans to sign up hundreds of end users and have wound up peddling their systems to dealers and consortia. Consortia, meanwhile, have attracted some of the best and brightest on Wall Street and have shown surprising spunk. And firms like Citibank and Credit Suisse First Boston have demonstrated that if you build an attractive system, clients will come.

Our focus in this issue is on systems that allow users to trade derivatives contracts. For example, we present the first in-depth look at SwapsWire, the new interdealer trading consortia that has signed up virtually every player in the swaps world. We've also reviewed a number of systems that offer cash investments but have plans to expand into derivatives.

We've tried to go beyond a simple listing of initiatives, and give our readers a sense of how good these systems really are. Our secret weapon in this effort is Barclay Leib, a 20-year veteran of derivatives sales and trading, who has held senior positions at JP Morgan, Goldman Sachs and other firms.

Leib wrote his first feature story for the magazine in 1996. He now runs a successful fund of funds and, in his spare time, manages to grind out thousands of words per month. Since he joined the staff, he has brought a sophisticated edge to the magazine's reporting, with breakthrough cover stories on bandwidth trading, Amex market-making and the upstairs shenanigans at electronic options exchanges.

In this issue, Leib takes many of these systems for a test drive—and isn't shy about telling readers what he likes and dislikes. Other publications have equally talented reporters, but to my knowledge, Leib is the only former derivatives trader on the staff of a financial magazine.

The Achilles' heel of electronic trading is liquidity. Most systems have not yet attracted enough volume to sustain a true marketplace. In many cases, it's more difficult to trade electronically than it is to trade over the phone.

Things are bound to change quickly. In 1997, fewer than five percent of retail equity traders were electronic. Now the figure is closer to 50 percent.

Electronic trading will inevitably become easier and more efficient as financial institutions wire their front, middle and back offices together in one seamless web. But the key isn't technology. The experience of last year has taught us one lesson: when comes to building liquidity, it's relationship, relationship, relationship.