Three Brokerage Powerhouses Bring Bond Trading to the Net - TheStreet

Updated from 8:23 a.m. EDT

Three major investment firms announced plans Tuesday to bring the Internet revolution to bond trading.

Goldman Sachs

(GS) - Get Report

,

Merrill Lynch

( MER) and

Morgan Stanley Dean Witter

( MWD) joined forces to create

BondBook

, a new electronic exchange for the fixed-income markets.

While stock trading has flourished online, bonds have not. This system will allow direct trading between investors and, according to the firms, will allow for greater price transparency and higher liquidity.

"BondBook's formation answers the market's call for a more open structure, improved transparency and greater liquidity," the three investment firms said in a statement. "It marks an important step forward and underscores our commitment to the integrity and quality of the fixed-income market."

Initially, trading, set to begin in the fourth quarter, will involve investment-grade and high-yield, or junk, corporate bonds and municipal bonds. Once the new trading platform is operational, the firms expect to branch out into other products and markets.

As joint owners, the three securities firms will provide initial financing, core technologies, system development and personnel to start the company and develop the trading system.

The Internet has typically been the domain of the young. Hence, stock trading online has boomed, since younger investors are more inclined to take risk, explained Jim Van Dyke, a financial services analyst at independent research firm

Jupiter Communications

. Older investors that are more risk averse tend to put much more of their money in bonds.

Another explanation for why bond trading hasn't exploded online, offered by Myles Harrington, the president of online auction house

MuniAuction

, is that fixed-income investments are more complicated for retail investors to understand. "I think it's going to take a long time to go to the retail market," said Harrington, a co-founder of his Pittsburgh-based company, which created a marketplace for selling municipal bonds online to institutional investors with at least $50 million in assets under management.

Still, the retail market does have potential. An estimated 30% of the $3 trillion to $5 trillion American bond market is held by retail investors, he said, who mainly buy the investments on their broker's advice and not because they understand the nuances of bond yields. Municipal bonds, for example, are popular with older investors because the bonds are largely risk free and their yields are sheltered from state and local taxes.

Even though the three investment firms control an estimated 35% of all bond underwriting in the U.S., Harrington questioned the significance of the announcement, saying that the other 65% will have no incentive to use the new platform. A truly revolutionary idea, he said, would be an electronic marketplace that cuts out the broker by bringing investors and issuers together directly, which MuniAuction does, albeit for wealthy investors. Myles called the announcement "more Internet hype."

In the world of online stock trading, large investment firms have often followed upstart Internet firms such as

E*Trade

( EGRP) or

Ameritrade

(AMTD) - Get Report

in offering services online. Thus the move by Goldman, Merrill and Morgan Stanley can be seen as a "defensive" play to grab a hefty share of the market for online bond transactions before Internet-only firms get the lead, Van Dyke said.

"We're seeing that traditional financial services companies need to band together to defend themselves from upstart companies," he said.

BondBook will focus on institutional investors, and follows another recent announcement by a group of investment banks -- in this case Merrill, Morgan Stanley Dean Witter,

Salomon Smith Barney

and

Chapdelaine Electronic Brokerage

-- that it was forming

TheMuniCenter

, a Web-based marketplace for municipal bonds.

The formation of the new trading platform appeared to hold little sway with investors. Shares in Merrill in afternoon trading Tuesday were up 1/2 to 109, while Goldman, Sachs also rose slightly, up 5/8, or 1%, to 83 15/16, and Morgan Stanley Dean Witter climbed 7/16, or 1%, to 81 1/4. (Merrill finished 1 1/2, or 1%, higher at 110; Goldman, Sachs ended up 1 13/16, or 2%, at 85 1/8; Morgan Stanley Dean Witter ended up 2 9/16, or 3%, at 83 3/8.)