Vol 6 No 42
CONNECTIVITY
Lutnick Taking eSpeed into FX, Swaps
NEW YORK--With its positive earnings period as a backdrop, interdealer electronic broker eSpeed is hoping to parlay its success in the U.S. Treasury bond market as a springboard into the foreign exchange (FX), mortgage-backed securities (MBS), and interest-rate swaps markets, eSpeed’s president, CEO and chairman Howard Lutnick tells TTW.
However, industry analysts are skeptical that the eSpeed platform can gain ground beyond the e-broker’s core market, citing the firm’s limited ability in the past to break into new markets.
Even so, eSpeed is looking beyond the 700 primary dealing banks participating in the system, including professional traders, money managers, and futures firms, officials say.
Excluding a one-time insurance payment of $12.8 million related to the Sept. 11, 2001 attacks that devastated the firm and its parent, broker Cantor Fitzgerald (TTW, Sept. 24, 2001), eSpeed earned $13.9 million in Q3 2003, a 92 percent increase over Q2 2003. Revenue grew 28 percent to $39.1 million.
For the FX foray, eSpeed has already gone live with spot FX, with a full rollout expected in Q4 2003. The MBS and vanilla swaps assault is due in Q4, Lutnick says. The company will also add "contingent order" (CO) functionality for Treasuries in September.
This means traders can execute multi-leg trades with more confidence, Lutnick says.
"Contingent orders allow traders to execute multi-part trades with a proprietary ‘never-miss’ guarantee," Lutnick says. As an example, when the CO function is used, a trader will be able to sell an old note only if the trader can buy the newly priced note at the desired spread.
ESpeed hopes CO will repeat the success of its unconventional "price improvement" (PI) function introduced in January, which allows a trader to leapfrog other traders’ bids and offers by paying extra commission. Most e-trading platforms operate on price-time priority or rely on market makers. But the PI helped drive eSpeed’s commissions up 10 percent, and its net operating margin to 35.5 percent, officials say.
ESpeed’s FX trading methodology will be similarly unconventional for that market: It will be fully anonymous, Lutnick says. Most FX platforms operate on a disclosed, "name give-up" procedure. Two large FX banks have already joined, and users will most likely use anonymity for one side of a trade, while using another platform for the other side, Lutnick says.
"We know that an anonymous market can reside next to a name give-up market," Lutnick says. "Sometimes you want to tell people you’re a seller while you’re anonymously buying."
Lutnick declines to name the banks, but analyst Richard Bove with Hoeffer & Arnett speculates that UBS and Deutsche Bank are the prime candidates for the new eSpeed service. Ed Hulina, head of marketing for FX and money markets at UBS, says he is unaware of the eSpeed service; Deutsche Bank officials decline comment.
To accommodate the new markets, eSpeed will use some of the 46 pre-built market types in its C++ matching engine, says Lutnick. "We’re already connected to banks through their firewalls and into the back office, so the marginal cost of introducing new things is very low for us," Lutnick says. "We’ve already done the development; the system operates at 15 percent capacity. We’ll keep it that way, by adding network and hardware capacity."
Besides adding more Sun Microsystems Enterprise-series servers to complement the Sun and Hewlett-Packard Alpha machines already in place, eSpeed’s expansion also means hiring a raft of salespeople for each new product area, though Lutnick declines to estimate numbers.
It also means first offering Internet connectivity via eSpeed.com to firms not currently on the eSpeed network, with the eventual intent to run private lines, says Lutnick.
While analysts have little to complain about in eSpeed’s current results, they note that the company’s current business is heavily dependent on the U.S. government’s debt issuance and that the company hasn’t proven itself in other markets.
"We believe a significant portion of [eSpeed’s] increased volume is related to the recent strength in new issuance," writes Richard Repetto, an analyst with Putnam Lovell Securities. "[ESpeed’s efforts] to grow revenue and earnings through additional products … [have] yet to gain firm traction."
ESpeed has a proprietary position in "a rapid growth market," Bove says. "The company, for its lifetime, has argued that it can sell higher, value-added products or that it can expand horizontally, but to this point it has not truly succeeded in either effort, though it has done very well in its core market."
Repetto cites energy broker TradeSpark and Canadian interdealer brokerage Freedom International as eSpeed ventures that have yet to match the success of eSpeed’s primary offerings. Lutnick says he believes that the cost efficiencies of eSpeed’s electronic platform--which offers discounts of as much as 70 to 80 percent off voice brokers for large volumes in when-issued and off-the-run Treasuries--will draw traffic away from voice broking in the new markets as well.
In other matters, eSpeed’s preliminary motion for an injunction to stop Icap’s BrokerTec from trading and allegedly infringing on its "580" patent (TTW, July 7) will be heard in a federal court in Delaware in October. Its litigation against the New York Mercantile Exchange (Nymex) for Wagner patent violation (TTW, Nov. 5, 2001) is still pending, Lutnick says.
Daniel Safarik
