Only a few years ago, the electronic-trading landscape was one in which the major players were small software companies that were sometimes attached to agency brokers; these small software providers were running circles around their full-service competitors. Now, those same full-service brokers have acquired the vast majority of the direct-market-access (DMA) providers and are busily folding them into their full-service environments.

Within the last two years, Bank of America, Bank of New York and Citigroup acquired Direct Access Financial Corp., Sonic Trading Management and Lava Trading, respectively. This means that these brokers now own some of the companies that stole away buy-side order flow as buy-side firms searched for faster executions for lower fees. Brokers now are challenged to provide the value that buy-side clients originally sought from the DMA firms - primarily low-cost trading without interference from sell-side traders - while incorporating them into the broader range of services that large brokers typically charge premiums to provide. Meanwhile, other full-service brokers, such as Morgan Stanley and Goldman Sachs, in addition to independent agency brokers such as ITG and Instinet, must decide how to enhance their pre-existing DMA services to keep up with the brokers that recently have made acquisitions in the direct-market-access field.

Most of the large brokers seem to have convinced their DMA clients that they will continue to provide the services that clients expect at reasonable rates. But, where will brokers take DMA next? So far, firms seem to be tentatively headed in all directions; international equities, foreign exchange and derivatives seem to be in everyone's plans, but it's clear that the gangbusters expansiveness of the booming '90s isn't making a comeback.

International Intentions

Some brokers are recognizing the increasingly international nature of trading. Goldman Sachs has undertaken a "tremendous drive to globalize and broaden" REDIPlus, its DMA platform inherited through the acquisition of Spear, Leeds & Kellogg (SLK) in 2000, according to Greg Tusar, head of electronic execution product development at Goldman Sachs Execution and Clearing, the new operating name for the former SLK business.

On Jan. 18, Goldman announced that REDI users can now trade foreign exchange (FX) in up to 15 markets. The impetus came from customers that need to fund their foreign equities trading immediately upon execution.

"We have talked with Hotspot and FXall but have not yet decided how to go forward," says Tusar. "The liquidity provided by Goldman is currently more than enough."

REDI also has been strong in U.S. options for several years, currently trades all U.S. electronic futures and is looking to expand into European options sometime this year, Tusar adds. "Hedge funds, in particular, are driving this, as well as smaller funds that have consolidated into multistrategy, multibillion dollar funds," he explains. "Quantitative rebalances, managed futures, commodities trading advisers ... [multiple markets functionality] really resonates with those kinds of clients."

Investment Technology Group (ITG) also is Europe-bound in the first quarter of 2005, says Frank Troise, managing director of direct market access and algorithmic trading at ITG. The firm will connect users of its Triton platform to the London Stock Exchange, Xetra and Euronext. But domestic cross-markets capability also is a large concern, and Troise alludes to what may well be the next trend in DMA.

"We are not really in electronic options, but it is a customer requirement," Troise says. "Our intention is not to build this in the back room. ... We will find a vendor [from which] we can license or purchase [the technology]," he continues. "Electronic options and futures are a lot younger - that's why no one has yet made an offer for these technology companies," he explains.

For Citigroup, which has an enormous international presence, the challenge is how to make Lava effective in that marketplace. "Lava today is not in European securities, although European users can use Lava to trade U.S. securities," says Nobel Gulati, chief operating officer of Citi's Advanced Execution group. "Currently, Lava doesn't have capabilities in Europe," he says, adding, "We are working on that. Internationalizing is a goal we have in 2005." Clients can expect to see Lava's unique synthetic order types used in any future Citi offerings. And even before the Citi acquisition, Lava offered FX trading, Gulati points out.

BNY also has plans to align its Direct Execution (DEx) more tightly with international markets by directing users of the DMA platform to G-Trade, the international equities trading unit of BNY Brokerage. But the broker has not made expansive plans to internationalize Sonic, since its larger clients don't necessarily have global trading goals that align with their Sonic desktop licenses.

"We have not seen the demand yet," says Carey Pack, BNY Brokerage's president. Many traditional buy-side firms "keep their U.S. trading desks separate from international; most of them are in London or Europe. When you get to smaller hedge funds, then you have [global] trading operations all on one desk. Many want a single platform. We are assessing that demand versus our other target markets."

The key for many of the new DMA owners seems to be in broadening distribution of their existing U.S. equity services through third-party order-management-system (OMS) vendors. Early this year, BNY Brokerage extended its DEx platform, which now incorporates Sonic, to the Macgregor XIP Order Management Network (OMN), allowing Macgregor clients to direct order flow from XIP on their desktops through DEx to ECNs and the New York Stock Exchange. This means Macgregor users can also take advantage of the SonicPort front end, which offers pegged and discretionary orders, Web-based trade data reporting, risk management tools and trade support from BNY traders.

"We are trying to make it easy for clients to use our trading partners," says BNY's Pack. "They can call up DEx and be able to use that to send orders to us."

Citigroup is also at work integrating Lava with several OMS providers, says Will Geyer, head of Citi's Alternative Execution Services (AES) unit, although he declines to name specific companies.

End of the Gold Rush

One conclusion seems certain: If firms still are shopping around for U.S. equity DMA providers to acquire, they are probably too late.

"Part of the story is that the gold rush is coming to an end," says Dushyant Shahrawat, analyst at market research firm TowerGroup and author of several reports on DMA. "All of these independent providers like Sonic and Lava would not have sold if that were not true," he continues. "Who doesn't want to be a public company with a $1 billion market cap? The fact that the market is not as lucrative as it was is why they agreed to be bought."

It seems clear that most brokers will not be able just to sit on their DMA assets, even if they don't go charging into foreign derivatives or FX right away. TowerGroup expects that the DMA market already has peaked out at 38 percent to 39 percent of U.S. buy-side equity shares traded, Shahrawat says. Also, having forked out several hundred million dollars for these firms, most brokers probably will be loath to spend more money to extend the services without a distinct demand.

"Membership on a foreign stock exchange doesn't directly connote connectivity," Shahrawat says. "Some of these markets have infrastructure problems endemic to their market that don't allow this type of connectivity. While jumping up and down saying they have support for non-U.S. equities, brokers want to be sure that while they extend the offerings that they really have a market," he continues. "But it is not clear that there is enough of an appetite for this. Brokers are not at a stage where they are as convinced as they could be of buy-side demand."

Meanwhile, back at home, the large institutional block trading for which buy-side traders originally turned to brokers has changed forever with the use of algorithmic trading; and as the search for best execution and low commissions intensifies, the most likely near-term scenario is that brokers will attempt to enhance DMA platforms so that they will act as portals to all of the firm's services, regaining some of the buy-side order flow that was lost from the block-trading desk.

For example, BNY is focusing on using DEx/Sonic as a portal to its existing agency brokerage services. "What we are working on is commission management and multibroker capabilities," BNY's Pack says. "That is our next major development, along with access to algorithms. That's not to say international is less important - we are still trying to sort through the requirements."