Investing in the Future

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The Internet isn't going to change the way Ralph Constantino does business. It already has. "What the market is saying, is that this is our preferred way to talk to you," said Constantino, director of the global marketing group at State Street Global Advisors. "Customers are e-mailing us unprompted."

For your average Silicon Valley firm, this is hardly radical stuff. But in the high-touch, clubby worlds of wholesale and investment banking, it's revolutionary.

The Internet has collided with the b-to-b banking world. Depending on whom you ask, it is either the Grim Reaper or a harbinger of a great new epoch. What is becoming apparent is that it will change the business more than any force since the Great Depression.

Web converts among financiers sound almost giddy when describing how the Internet will allow them to get more customers, especially smaller ones they currently don't have time for.

Early adapters such as State Street, Merrill Lynch & Co., Chase Manhattan Bank Corp., Bank of America Corp. and J.P. Morgan & Co. are trying to reach these new clients through proprietary portals, new Web units and countless joint exchanges. Some of these projects are already up and running; most are still being planned.

Meanwhile, Luddites--no small camp among bankers--fret that these portals and exchanges will cut them, and their Trumpian salaries, out. This is because most big financial transactions today still require a breathing, commission-receiving middleman--the banker. The Internet threatens to take this middleman's place.

Most investment banks' proprietary Internet projects are aimed at small and midsize customers. These clients, with annual revenues of between $10 million and $100 million, have until recently been passed over by the big New York investment banks. After all, it made little sense to put a $2 million-dollar-a-year investment banker on the account of, say, a small New Hampshire granite company. "Once you reach a company the size of $30, $40, $50 million, you can't dip below it for a lot of reasons," said Kevin Albert, a Merrill Lynch investment banker.

But lately the big financial houses, led by Merrill, have discovered what the investment banking arms of regional banks have known all along--that these small companies' business, when aggregated, can make them lots of money. And, the big investment banks are starting to use the Web to make this happen.

New York-based Merrill made a splash when it recently launched Direct Markets Online, the first portal aimed at institutional investor clients. It allows Merrill's b-to-b clients to do all their business, from research to trading, online.

The investment bank recently strengthened its mid-market Internet blitz through a deal with CapitalKey Advisors, a New York-based online investment bank. Merrill and CapitalKey will jointly serve clients over the Internet.

Setting up exchanges

Big investment banks are racing to launch joint exchanges, most of them for trading bonds. All are still in their infancy or being built. These exchanges' collective potential is enormous, as trillions of dollars in bonds are traded annually.

Most bond trading today is done among three parties: the debt issuer, the buyer and the go-between bank salesperson, who writes tickets and works the phones. The threat, or forgone conclusion, is that issuers will one day sell their debt directly to buyers. The investment banks are setting up the joint online exchanges to stay in the loop.

The idea is that salespeople will be able to keep their jobs by spending more time providing service to customers, instead of doing grunt work like entering orders for them. This, the customers can do for themselves over the exchanges.

New financial Internet exchanges, meanwhile, are coming at a rate of nearly three a month.

Just last week, Merrill, Morgan Stanley Dean Witter & Co. and Goldman Sachs & Co. announced they will form BondBook L.L.C., an exchange for corporate and municipal bonds. BondBook L.L.C.'s impact could be significant; its backers control about 30% of all global fixed-income trading.

Another key exchange is Market Axess, a bond trading platform being launched by Chase, Bear Stearns & Co. and J.P. Morgan & Co.

Indeed, J.P. Morgan & Co. has taken a lead among investment banks in dedicating a division to the Internet. LabMorgan, launched earlier this year, has a $1 billion war chest and is investing in Web projects inside and outside of J.P. Morgan. "They are leading in reinventing the whole infrastructure around bond trading," said Chuck Farkas, director of Bain & Co.'s global financial services practice.

Commercial banks are lagging

Most b-to-b e-banking innovation so far has happened at investment banks rather than commercial banks, which have until now spent most of their time and money on developing consumer online banking packages. "Basically, wholesale banking is less glamorous than consumer banking," said Rajeev Agarwal, senior analyst-wholesale banking practice at e-finance consultancy TowerGroup. "That's why it has lagged behind."

Recently, however, commercial banks have turned their attention to wholesale, or b-to-b, Internet banking. Some brokerage analysts panned what banks have offered so far. "We've generally been disappointed," said Michael S. Hodes, Goldman Sachs & Co.'s VP-securities analyst, e-finance, "and see a lot of room for improvement."

Still, commercial banks have made some impressive b-to-b strides over the past eight months. Citigroup, Chase, Wells Fargo & Co. and Bank of America Corp. have taken the lead.

Citigroup made a splash late last year with, a project that has the bank building transactional Web sites for its business customers. New York-based Citigroup started to fend off the tech vendors, which typically do this type of work.

Wells Fargo this month will become the first bank to introduce a full-service corporate banking portal. Bank of America's and Chase's b-to-b projects are covered extensively later in this special report.

TowerGroup's Agarwal said these projects foretell a b-to-b wholesale banking boom that will be fueled by what banks do best--invest lots of money. "Banks are looking at investing hundreds of millions of dollars in b-to-b the next few years," he said.

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