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April 30, 1999

Market-Maker Survey: The Coming Revolution

By John A. Byrne

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  • Market-Maker Survey: The Coming Revolution
  • Page 2

The rising volume of online retail order flow is bringing revolutionary change to market making in Nasdaq stocks.

Profit margins declined at many market makers in the past 12 months, continuing a trend fueled by federal regulations and trading in smaller fractions. But many firms are offsetting the margin squeeze with increasing amounts of online trades.

These firms are led by large wholesalers that benefit the most from online orders routed by smaller broker dealers. Topping the group in transaction volume are, in descending order, Knight Securities, the Nasdaq arm of Knight/Trimark Group, discount-brokerage giant Charles Schwab & Co.'s Mayer & Schweitzer subsidiary, and Herzog, Heine, Geduld, according to Boston-based AutEx.

The continuing profit-margin squeeze and the ascension of powerful wholesalers are some of the highlights of Traders Magazine's latest survey of market makers for the 12-month period ending March 31, 1999. These wholesalers make markets in a vast universe of over-the-counter stocks, including OTC Bulletin Board and Pink Sheet securities.

Knight Securities said it plans to increase the number of stocks it trades by ten percent in the coming 12 months, to slightly more than 8,100. Mayer & Schweitzer did not respond to the survey, while Herzog, Heine, Geduld projected increasing the number of individual stocks it trades, though it did not quantify the number.

The Charles Schwab subsidiary currently makes markets in about 6,500 stocks, while its cross-town rival Herzog, Heine, Geduld trades roughly 5,200 stocks, according to AutEx.

"We plan to make markets in every single stock on Nasdaq," said Kenneth Pasternak, president and chief executive of Jersey City-based Knight/Trimark. "The Internet is bringing revolution, and we are very bullish"

Knight Securities, the youngest and most successful market maker, had the benefit of $25 million of technology spending, with a further $20 million earmarked for 1999.

"We see the firm increasing its market share in Nasdaq trading," said Bryan Keane, an electronic financial-services analyst at BankBoston Robertson Stephens. "The firm has been very successful in getting online order flow and increasing their institutional business at the same time." (The investment-banking giant was lead underwriter in Knight/Trimark's 1998 initial public offering.)

Like many other market makers today, Knight Securities uses technical analysis to make fast decisions on how to position stocks profitably. "A good firm wants to be long on a stock when there are a lot of buyers, and to be short before everybody dumps the stock," Keane said.

Wholesalers, with lots of liquidity, don't face rigorous competition from electronic communications networks (ECNs) for order flow. That's despite a perception that ECNs' stock-trading muscle can intimidate trading desks in general.

"If I send my trade to an ECN, I am not guaranteed liquidity," Keane said. "If I go through a large wholesaler, I know it has the biggest book of business. I am guaranteed best execution."

Overall Picture

Meanwhile, the overall picture for market makers bodes well for large desks, while some doubt and uncertainty remains for smaller, less-capitalized firms, according to the survey. All told, 37 market- making firms responded, covering a representative sample of top market makers as well as medium and small-sized desks.