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June 30, 2000

Cover Story: The Case for a Call Auction

By Peter Chapman

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The New York Stock Exchange has one. The American Stock Exchange has one. Will a call auction work for Nasdaq's opening?

Buyside traders hope so. They don't like how trading starts at the 9:30 a.m. open with unequal bids and offers on some stocks. As they see it, a call - operated electronically - would eliminate that confusion. A call, in short, would provide a single price open on these stocks, letting traders execute big orders faster.

The Securities and Exchange Commission doesn't like the current Nasdaq opening either and is pushing the market for a single price open.

The clamor has made Nasdaq's unruly opening the latest battlefront in the war to reshape the dealer market into a order-driven auction. Regulators, academics, and the buyside, are leading the charge.

The SEC-decreed limit order handling rules and Nasdaq's various limit order book proposals have had the most impact. Nasdaq wholesalers which execute other dealers' trades, have the most to lose and are offering the most resistance to the change. They fear a call would disintermediate their role. Dealers that serve institutions appear resigned to change.

At the heart of an electronic call auction is a computer software program that matches buy and sell orders at a price determined by their interaction. It is a price-discovery mechanism. As such, it differs from the popular electronic crossing offered by Instinet and others. That system uses a reference price from the continuous market to match orders. An electronic call is little used in the U.S. A manual call opens trading every day at the New York and American stock exchanges. The specialist does the work normally done by the computer in the electronic systems.

AZX Deal

The buyside generally likes the service it gets on the NYSE in the morning and is demanding similar treatment on Nasdaq. Its efforts seem to be bearing fruit.

Since late May, a group of investment banks led by Goldman Sachs has provided support for a 9:29 a.m. electronic call auction run on the Arizona Stock Exchange for Nasdaq stocks. AZX, the parent company, was near death earlier this year when Goldman reportedly bought a 25 percent stake. Liquidity on the new auction, which is run independent of Nasdaq, is respectable. Buysiders, such as the mammoth TIAA/CREF, have waded in.

"We are going to show the world how Nasdaq could open with a multi-party auction," said Steve Wunsch, president of AZX. "The Nasdaq process needs to be fixed."

AZX has been around for 10 years, but has been used chiefly as an after-hours crossing network in Nasdaq stocks. Volume has averaged about 10,000 shares per day and its financial position is precarious. The deal with Goldman could prove fortuitous.

A second line of attack is also making progress. Nasdaq's Quality of Markets Committee, in which nine of its 20 members are on the buyside, is submitting a proposal to the Nasdaq board to incorporate an electronic call auction at the opening. Nasdaq is under pressure from the SEC to change its pre-opening and opening procedures. It must do something, but faces dealer resistance.