A number of specialist firms and major players are looking at developing a role in the fledgling market for bandwidth, which is the range of frequencies, or the volume of data, that a transmission line can carry. At the moment trading is mostly limited to spot transactions, but many see potential for forwards and possibly other derivatives. This Learning Curve looks at the state of the market now, and what officials predict may happen going forward.
THE FIRST COMMODITIZED FORWARD?
Until bandwidth and minutes broker Arbinet Communications executed what some industry officials deemed the first over-the-counter commoditized bandwidth forward trade in July, the commodity was only traded through minutes barter firms, such as MIN-X.COM and Band-x (DW, 7/26). "It [was] a major carrier saying 'I want to trade through an exchange.' Traditionally, carriers go to other carriers and ask 'What do you have?' [Now] they are asking sellers to bid for it," said Alex Mashinsky, chairman of Arbinet in New York. He suspects that the desire for anonymity prompted the carrier to use an exchange. "Carriers don't want others to find out what they are doing," he added. However, some industry officials argue that the trade does not qualify as a commoditized bandwidth forwards trade because it took months to close.
The trade was for a basket of orders of raw bandwidth, which can carry telephone and video quality transmissions. The notional size of the trade was USD100 million. It was made up of several smaller trades to about 15 different destinations, and it should take a few months to use up the contracts in the basket, Mashinsky said, declining to name the Asian counterparty in the deal.
WHAT'S NEXT?
Some industry officials argue the underlying does not meet the characteristics of a typical commodity, because it is not a finite resource and there is a constant downward pressure on price. Nonetheless, this may not be an impediment as carriers are keen to get the market started to reduce further the cost of traffic.
International telecom players are expected to be early entrants into the market, because they own the fiber optic cables that carry e-mail, video and telephone transmissions. Internet service providers and Fortune 500 companies, both large consumers of bandwidth, will be the next market entrants, according to Thomas Gros, vice president, global bandwidth trading at Enron Communications.
Enron, which is plotting a fourth quarter entry to the market as a bandwidth forwards principal and market maker (DW, 5/3), and AIG Telecom are two of the major players that have dedicated resources to trading bandwidth forwards (DW, 4/12). But they are planning different strategies. Enron aims to be a bandwidth forwards market maker and occasional principal, while AIG Telecom will be a principal to every trade. "Carriers are eager to execute trades and as a matter of convenience, they may stay with early market entrants," noted Eric Raab, managing director at AIG Telecom in Greenwich, Conn.
Firms looking to offer anonymous trading between counterparties will need a high credit rating if they are to act as counterparties, because of the billing and settlement issues between buyers and sellers, Raab said. Enron's Gros added that no physical telecoms infrastructure will be required and participation in the market will require only a small capital investment.
THE OBSTACLES
Several roadblocks, including standardization and illiquidity, may impede the development of the nascent commodity. Arbinet has sought to tackle this through a strategic alliance with EC tel, an independent automated monitoring company in Tel Aviv that measures the quality of telecom traffic. The alliance was sought to standardize the terms of minutes and bandwidth in forward contracts.
The inherent downward pressure on bandwidth pricing also may hinder the expansion of forwards trading as carriers' main interest is in cost arbitrage, according to Bob Baulch, managing director of international traffic at AT&T in New Jersey. "Bandwidth pricing is only going in one direction: down," added Marc Montagner, principal responsible for communications finance at Morgan Stanley Dean Witter in New York. Montagner noted that on the surface the trades seem one-sided.
The rapid pace of technological advancement also may present problems. "It is an infinitely updateable service," asserted Marcus de Ferranti, director at Band-x in London. Enron's Gros said the firm visited most major players in the telecoms industry this year to tackle this issue. Enron's aim is to design a pooling point system that allows for connections and hardware to be updated by a third-party pooling administrator, Gros said. The pooling point will be run and updated by a soon-to-be selected pooling point administrator and available to all market participants, he added.
In an effort to enhance liquidity market entrants are scrambling to create viable benchmarks for the commodity. Enron currently is looking into establishing several city pair benchmarks for bandwidth. New York to London looks attractive, as there is a lot of volatility and a lot of incentive to manage and trade it, Gros said. A U.S. East Coast-West Coast city pair, such as L.A. to New York, that measures bandwidth in monthly units, is another front runner for a benchmark, he added, noting that an L.A. or San Francisco to Tokyo pairing also may evolve. The logic for that pairing is its usefulness as a springboard to Europe and Asia, he said.
In a typical commoditized bandwidth trade, a counterparty would call up a seller asking to buy a specific quantity of bandwidth for a certain time period. Next, the counterparties negotiate the commercial terms of the trade--price, time, and whether the counterparty is interested in buying or selling--via a pooling point administrator from a global hub. Then, the pooling point administrator gives each counterparty code numbers for the deal to enable the trade's participants to track, in real time, the quality of the service for physical delivery.
Raab said AIG's trades will be based on usage time and delivery periods, with payouts determined by timecounts and traffic type. Quality will be assessed by transmission functions rather than voice compression. The firm has found a way to bypass voice compression snags, he said, declining to elaborate. Some industry officials speculated this issue could impede trading.
The Chicago Board of Trade has explored the feasibility of exchange-traded option contracts on bandwidth, but it is unlikely that bandwidth will be converted into a futures format, said John Harding, v.p. product research at CBOT. "You tend to get more problems than solutions," he said. It is unclear if bandwidth is suitable for a futures contract because telecoms technology keeps changing. Standardization, however, would present the biggest hurdle because products are rarely relevant for more than three months, Harding said. The limited number of providers in the market is also an obstacle, he added.
This week's Learning Curve was written by Jeany Haggerty, a reporter with Derivatives Week.
