Napster-Like Peer-to-Peer Systems Spread

The courts may have brought Napster to its virtual knees, but other peer-to-peer applications are still alive and kicking-and not just in the music business. Wall Street firms have been getting into peer-to-peer, with applications that let users trade research reports and equities without the benefit of intermediaries.

Peer-to-peer, or P2P, systems let the network-as opposed to the computer-take on more of the work burden. They may also make better use of the Internet than other applications, help form communities and take pressure off a company’s central servers. The downside is that developers and IT managers need to be aware of security, privacy, copyright and bandwidth issues, as any college network administrator has come to know too well. Companies have also learned from Napster that applications need to be easy and convenient, in addition to offering something that users want.

The two major peer-to-peer companies gaining traction recently on Wall Street exemplify this trend-WorldStreet Corp., and LiquidNet.

LiquidNet, which began operating in April and had ramped up to trading 4 million shares a day in June (Securities Industry News, June 18), allows institutional investors to trade stocks the same way Napster lets college kids trade music-anonymously, efficiently, and without benefit of the traditional sales channel.

The system currently averages about 5.6 million shares traded each day-not that large a volume compared to ECNs and other trading channels. However, while the average order size on an ECN is around 300 shares, and about 800 shares for the industry as a whole, the average LiquidNet order size is 71,000 shares, said company spokesman Alfred Eskandar.

A trader doesn’t have to do anything extra to use LiquidNet-the system automatically searches the order management systems of participating institutions for matches. When a match shows up, traders can anonymously negotiate the details of the trade, Eskandar said.

And the reason for the large order sizes is that there’s no leakage of information at LiquidNet, said Kevin Cronin, head of equity trading at AIM Advisors.

“Our needs aren’t being addressed to the degree we need by NYSE and Nasdaq,” he added. “There’s information leakage out there. Everyone’s afraid of leaving an order on the book for fear of being front-runned. And the penny environment has created this whole new group of enemies for us-the day traders and the penny jumpers. That’s a further lack of incentive of having our limit orders on the books. All these advances were supposed to help investors, but they’ve done nothing for the institutions-if anything, they’ve made our life more difficult.”

LiquidNet helps solve this problem by matching up institutional buyers and sellers, by passing the traditional broker-dealers. Since the system integrates into existing order-management systems, it’s easy to use.

The only problem so far is the lack of liquidity, said Cronin. “The number of hits we have relative to the number of orders is pretty small, but when we do have a counterside to our orders, we’ve been happy with it,” he said.

At AIM, 11 traders use the LiquidNet system, said Cronin. The one or two who don’t prefer program trading, he added. And he would recommend it to other institutions.

“If you’re true to your fiduciary obligations to your shareholders, it’s a hard sell not to be involved in this thing,” he said.

Cronin isn’t bothered by the possibility that LiquidNet might hurt his existing relationships. “I’m not in the business to appease the brokers,” he said.

But LiquidNet isn’t going to permanently change the shape of the market, said Todd Eyler, an analyst with Cambridge, Mass.-based Forrester Research. In fact, it might end up benefiting the very dealers that it seems to disintermediate.

“My expectation is that this would become a service that a dealer such as Goldman would offer to their largest customers,” he said.

WorldStreet also solves a buy-side problem: in this case, too much information. Institutional investors aren’t the only ones who suffer-sell-side firms may find that their research reports get buried and overlooked, said Eyler.

WorldStreet allows the portfolio manager to finely tune the information that comes in. The big question is-will sell-side firms begin to produce research in the XML-based formats that WorldStreet requires? Early WorldStreet customers are hoping that they will.

“They’re going to have to go this way,” said Robert Norton, VP and portfolio manager at Philadelphia-based Delaware Investments. “People will demand it and they will follow suit and provide what we want. There’s a big chicken-and-egg thing working here, there’s no question about that. But I think that they’re addressing a real need. And as you build up volume and as you build up awareness, you will garner a greater following both on the buy side and the sell side.”

While LiquidNet offers a clear financial advantage-better prices-the WorldStreet offers a more subtle advantage over traditional communication methods.

“It gives portfolio managers more time during the day to investigate one or two more securities,” said Richard C. Wilkie, VP of IT investment management services at Kansas City-based American Century Investments. “They can spend more time making decisions rather than searching for information.”

Like other peer-to-peer systems, WorldStreet is bidirectional-a portfolio manager can open a communication path with an analyst and send research reports, video and audio files, and other information back and forth. A portfolio manager can also route information that comes in to other team members-much like a standard e-mail system, except that it is more flexible and better able to sort the information that it passes along. “It really comes down to putting a lot of control in the hands of the portfolio manager,” said Wilkie.

Like LiquidNet, WorldStreet prides itself on being virtually invisible and intuitively easy to use. For example, Outlook users will have a couple of extra buttons and a new toolbar-there’s no need to switch to a different application to see reports that come through WorldStreet.

“You shouldn’t notice where Outlook ends and WorldStreet begins,” said WorldStreet CTO Bob Lamoureux. “Portfolio-management applications also have a framework for extensibility that allows us to go in and plug in our toolbar.”

WorldStreet also offers better security than traditional e-mail or Web-based distribution.

“With group publishing to the network, nobody knows who is picking up information,” Wilkie said. “We’ve actually gone to the extent of putting in an aggregation server on our side, behind the firewall and are now working on integrating it into desktop applications. By moving the servers back in-house, we’ve been able to maintain a good security level.”

Another area of interest in the peer-to-peer space is that of collaboration tools. Instant messaging and e-mail are two obvious examples of services that allow for closer interaction between employees and may, as a result, help a company’s bottom line.

When employees need a more robust environment, some companies are creating a central electronic meeting place for collaborative document development and a common depository of information. Others are opting for a more decentralized, peer-focused approach.

Groove Networks provides applications that fall into the second category. Groove, a young company, doesn’t currently have any financial industry clients but said several Wall Street firms are considering using its service.

It allows users to set up on-the-fly virtual meeting spaces where they can share documents, Web sites and applications in a secure, encrypted environment. The service, which has only been available since April, is especially effective at bringing together people on opposite sides of a company firewall, said Groove spokesman Andrew Mahon.

Ironically, Napster’s legal troubles have helped peer-to-peer development, according to Rob Hegarty, an analyst at TowerGroup.

“By not having Napster in the news every day it’s allowing people to focus on real business applications,” he said. “It has helped put the focus on some true peer-to-peer solutions that are solving business problems.