Trading Initiates Flurry Of Changes

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Online trading may get all the attention, but the Internet is doing more for the financial services industry than changing the way people buy and sell securities. It's also lengthening the trading day and transforming how transactions are priced and information is delivered. It's changing how investment banks deal with their commercial clients--and vice versa. It's creating an array of new products in traditional banking and altering the ways banks interact with their consumer and business customers.

All of this activity is pushing the industry's Internet spending to new heights. Securities companies alone will spend $6.4 billion on Internet technologies in 2000, up from $3.9 billion last year, according to the Securities Industry Association. What's more, these companies are spending more than half of their IT budgets on new application development--a combined $14 billion last year, according to the SIA.

"If you're not changing the functionality, the branding, etc., then people get bored," says Larry Tabb, an analyst at the Tower Group, which conducted the study for the SIA. Tabb notes that Internet apps have an average lifespan of about a year, compared with five years for client/server systems and up to 20 years for mainframes.

Certainly, customers are not satisfied with business as usual. Even Merrill Lynch, that bastion of full-service, commission-based investing, is just weeks away from launching the type of discount trading service it once belittled as hazardous to customers' financial health. The brokerage's chief technology officer, John McKinley, calls the development and deployment of Merrill Lynch Direct "one of the most important technology initiatives we have done in the past decade."

But Merrill Lynch won't be building its online trading business and systems from scratch. Just last week, Merrill Lynch disclosed that AT&T and Exodus Communications will host its Web offerings and provide network management services. And Merrill Lynch's acquisition earlier this year of D.E. Shaw, developer of the online trading system DESoFT, put it on the map.

"Shaw has gone through an entire cycle of learning and building and operating an online brokerage business," McKinley says. "The knowledge it brings, in terms of the unique regulatory issues and the best practices of presentation and user experience, was as much of an enabler of our efforts as anything else."

Charles Schwab & Co. has 2.9 million active online accounts--up from zero two years ago. A total of 67 percent of all Schwab customer trades are now done over the Internet, the company said.

"Our largest customer base is now online," says Vincent Phillips, Schwab's vice president of Web systems, who views Merrill's entry as a validation of what Schwab started three years ago.

Virtually all of the full-service financial firms are moving to the Web. Just last week, for instance, Morgan Stanley Dean Witter said it intends to leverage its Discover Brokerage subsidiary to offer full-service clients online trading.

The growth of online investing over the past year is astounding. There's $778.3 billion in online brokerage accounts, up from $420 billion last year, according to Jupiter Communications. Jupiter forecasts that will jump to $1.2 trillion by 2000 and $3 trillion by 2003. Some 16 million investors are still up for grabs.

But the explosion in online trading doesn't mean revenue from traditional financial services is drying up. For the first nine months of this year, for instance, Merrill Lynch not only added 100,000 accounts to its Merrill Advantage fee-based online trading service, but its investment banking, asset management and portfolio service businesses also set records, while its global debt business "is holding its own," the company says.

PaineWebber and other financial companies are similarly reporting healthy growth in their core businesses.

Supporting that growth is a range of new Internet tools. While Wall Street has a lot of work ahead to Webify its traditional businesses, Tabb says, most major financial houses are well along in their efforts to use the Internet to communicate with institutional clients and partners, and, ultimately, eliminate the spreads on securities and fixed income instruments.

PaineWebber this summer rolled out 13,000 Dell PCs running its Windows-based ConsultWorks asset allocation and research application to financial advisers. Combined with the firm's Internet-based ConsultNet network, advisors are now accessing client information such as updated portfolio balances from their homes and at clients' offices. The system also lets clients log in and view the same data their advisers are looking at.

PaineWebber plans to roll out a Web-based collaboration service that will let advisors and clients view and manipulate personalized data. For example, clients will get alerts when their bonds are maturing or options are about to expire.

PaineWebber also has begun distributing its fixed income research to institutional clients over the Internet, by targeted e-mail or on secure Web sites. Not only has PaineWebber sold more reports, but it's also now able to send alerts out in near real time. "We are dramatically improving the targeting of information to clients," says PaineWebber CIO Scott Abbey.

Likewise, its Prime Brokerage unit, which manages hedge funds, is using the Internet to let institutional investors place trade orders and access customized information. This, too, has eliminated paper-intensive processes and brought in more clients, the company says.

"This gives us a tremendous tool," Abbey says. "Instead of running basically a printing shop, producing thousands of pages of reports every day and trucking them all over the place, we put them on our Web site and clients are able to access their customized reports at their convenience."

Even old-line investment banks are embracing the Internet, albeit slowly. J.P. Morgan, which, among other things, sells derivatives to other lenders, still trades them primarily over the telephone and by fax because the process requires days of interactive negotiation.

But rather than let some pure Web start-up rewrite the rules on how derivatives are traded, J.P. Morgan, joined by PricewaterhouseCoopers, is leading an effort called FpML to develop standards for trading derivatives over the Internet.

J.P. Morgan already has buy-in from leading investment banks, including Banque Nationale de Paris, Chase Manhattan, Credit Suisse First Boston, Deutsche Bank, Lehman Brothers, Merrill Lynch, Morgan Stanley Dean Witter and Freddie Mac. Working with them to help craft technical specs are IBM, SunGard, Integral, Sybase and WebMethods. The specs will address data-sharing schemes for such functions as electronic trading, confirmations and risk analysis.

Online trading will begin transforming derivatives trading in the next year, but it's unclear exactly how, says Brian Lynn, a derivatives architect at J.P. Morgan and program manager for the FpML initiative.

"It's hard to predict what the outcome will be, because with increased liquidity there will be increased volumes, but margins may be reduced and players might change," he says. "So the competitive landscape may change."

Lynn adds: "Certainly it will speed up the process and reduce the number of errors and increase the volume we see."

Next Frontier
Indeed, bringing traditional investment banking, wholesale banking and global fixed income trading to the Internet is the next major frontier for financial services companies.

"We are just in the formative stages. The question is, what sort of model is most appropriate for investment banking functions," says Michael Mazza, technical director of Chase.com's Internet Project Office. "We have brought in management consultants and dotcom experts. We are seeing a lot of innovative ideas which are being prioritized and budgeted. I could see us going both up market and down market. There's the possibility of extending the whole deal-making process and bringing it online."

One possibility: business-to-business portals, where a company with multiple relationships with Chase gets a centralized, personalized view of everything, Mazza says.

Other Internet business-to-business services have already been launched. For example, through application service provider IntraLinks, Chase, other banks and third parties negotiate and establish terms and conditions for large syndicated loans. Another project is Indentrus, a consortium of banks looking to agree on a standard way to issue and exchange digital certificates, facilitating secure payment processing over the Internet.

Given the fact that Chase began offering retail consumers Web banking only a year ago, it has come a long way. On the retail side, Mazza says, Chase is rolling out new features every two weeks. For instance, just this month it rolled out a revamped Web site that lets customers access financial planning tools and information on foreign currencies, as well as a site that lets customers shop for consumer goods online.

Bank of America just launched a service under which the bank will design and host business customers' Web sites and transaction processing services.

The recent phenomenon of pure Web-based banks is pushing traditional institutions, normally a conservative lot, to take more risks and move faster. One of the most intriguing examples was BankOne's decision this summer to build its own pure Web bank, which in many ways competes with its brick-and-mortar business.

The cyberbank, called Wingspan, offers lower account maintenance, checking and other fees and higher yields on CDs and money market accounts than does BankOne, the nation's fifth-largest bank. "With Wingspan, they have lower cost structures because they don't have bricks and mortar and they can sell competitive products," says Dataquest analyst George Barto. "BankOne decided if pure Internet banks are going to take business away, they might as well eat their own children."

With nontraditional players such as American Express, Nordstrom and even E-Trade (which acquired Telebank earlier this year) getting into online banking, traditional banks can no longer sit still, Barto adds.

The slowest faction of the financial services industry to adopt Internet technologies is insurance.

Only 2 percent of all insurance sales are online, according to a Forrester Research survey of 50 large insurance companies, which found that 40 percent aren't convinced they need to sell online.

Forrester maintains that traditional insurers aren't organized to remake themselves for the Internet. "They don't have the temperament. They're going to have to buy someone," says Forrester analyst Bill Doyle. Meantime, pure Web companies such as InsWeb, Quotesmith.com and InsureMarket are selling their products online at a discount.

One of the biggest potential shake-ups in financial services is the move toward 24-hour Internet-based securities trading--contingent on there being enough buyers and sellers to ensure competitive price spreads. "In the long run, the ability to provide more liquidity after the primary markets close will be good for

the financial markets," Schwab's Phillips says. However, since batch processing is done after hours, the move to extended-hours trading is going to require additional systems to handle these processes, Phillips adds.

And where the traditional broker fits into all of this remains to be seen. "The broker has to change from being a transactor to a money manager," Tabb says. "The broker also has to accept this technology and use it. If they try to fight it, they are swimming upstream."