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Comment: Getting some skin back in the game

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Andy Nybo, a senior analyst with the Tabb Group, says a USD280m minority investment by nine dealers this week creates the opportunity for TradeWeb to become a predator in the global exchan

Andy Nybo, a senior analyst with the Tabb Group, says a USD280m minority investment by nine dealers this week creates the opportunity for TradeWeb to become a predator in the global exchange consolidation game.

This week’s announcement that nine dealers are paying USD280m for a minority stake in TradeWeb should come as no surprise to the financial industry – anyone with a trading platform that has managed to acquire and maintain liquidity in financial instruments is in play.

Consolidation is all the rage among the global exchanges and is no longer limited to just equities or highflying derivatives exchanges. The Boston Stock Exchange, OMX, Borsa Italiana, Indian Stock Exchange, Chicago Board of Trade, Eurex, ATD, International Securities Exchange, MTS – the list goes on and on.

The TradeWeb announcement is just another example of how hot the sector remains. Securities firms are critical participants in the exchange consolidation game, and they want back into TradeWeb. They want to have a piece of the action, as well as the control that goes along with it.

In 2004, Thomson acquired TradeWeb from its founding dealer consortium for USD385m. And just to make sure the dealers stuck around and provided support for the platform, Thomson agreed to pay an additional USD150m in ‘incentives’ through 2007 that were critical to the continued success of the platform.

The importance of dealer support (liquidity)
So why the incentives? A simple way to look at it is a guarantee of dealer participation or in another light payment for order flow. Fixed-income markets are one of the last remaining over-the-counter markets, and dealers are essential to its smooth operation, at least today. So Thomson made sure that the dealers would stick around and provide liquidity. But coincidentally, the incentive agreement expires this year…

So what were the dealers going to do? Would the dealers have walked and supported another, competing platform? Probably not. But I am sure that is one of the hole cards that Thomson feared, especially given the rumblings surrounding LiquidityHub, a trading venue that was supposed to attack the swaps market, a key battleground for future e-trading supremacy.

But building a system to replicate the success of TradeWeb would be a huge challenge – not just a technology challenge, but also a challenge of building the network, gaining eyeballs on fixed income trading desks, and ensuring that liquidity is available for all parties on the platform. And who wants the hassle of ripping out existing pipes and applications, retraining users, building connectivity and working out the bugs inherent in any new technology application?

Instead, Thomson and some of the largest participants on TradeWeb agreed to new terms. The dealers get a chunk of equity and continue to support the platform. Thomson remains majority owner and gets preferential access to data, an important asset to own, especially in today’s computer-driven trading environment.

At the end of the day, everyone at the table is happy. Dealers have a bigger say in the structure and operation of TradeWeb. Thomson maintains its connection with the industry-leading fixed-income trading system. Everyone gets to share in the current profits of the company and a voice in its future direction and strategy.

What happens next?
The ‘new’ TradeWeb will no longer be simply a bond-trading platform and will become a much bigger animal. In one giant leap, it will become a multi-asset class trading platform that enjoys the support of some of the largest dealers in the world. Its users will also have access to the AutEx global order routing network, as well as access to a host of upstream and downstream services provided by its majority owner. And let’s not forget the soon-to-be expanded global distribution network that will only be enhanced through the merger of Thomson and Reuters scheduled for next year.

Growth on the TradeWeb platform will come from a number of key areas. The total investment by the dealers includes USD100m that will be targeted at new product areas. One attractive growth opportunity lies in the OTC derivatives space. The partnership plans to invest heavily in the interest rate swap arena, a highly liquid area that has seen little electronic penetration to date. It also has greater designs on the equity markets, and will build out these services through enhancements to the AutEx products. Greater distribution and more asset classes will also contribute to the platform’s growth.

But to get ahead in today’s fast moving exchange environment, TradeWeb will have to look externally for its biggest growth opportunities. The new partnership provides significant flexibility for TradeWeb to go after both competing and complimentary opportunities. Exchanges, ECNs, dark pools and other trading networks are fair game.

And with deep-pocketed parents such as Thomson/Reuters and the partnering dealers, the competition had better pay attention. TradeWeb will surely be knocking on doors and kicking tyres in the coming weeks and months.

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