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February 1, 2001

The Evolution of an ECN: Archipelago ECN is joining forces with the Pacific Exchange to form an el

By Peter Chapman

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  • The Evolution of an ECN: Archipelago ECN is joining forces with the Pacific Exchange to form an el
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Here's a riddle. What's the difference between a stock exchange and an electronic communications network? The answer could soon be not much' if the Securities and Exchange Commission approves the Archipelago Exchange.

Chicago's Archipelago ECN has allied with San Francisco's Pacific Exchange (PCX) to form a totally electronic, for-profit, competing-dealer U.S. stock exchange to be called the Archipelago Exchange. It will trade both listed and Nasdaq securities. The proposal, submitted to the SEC in July 2000, has cleared the public comment period and now awaits a yea or a nay from the regulator.

If approved, it will be the only stock exchange in the United States to operate on the twin planks of openness and strict price and time priority. There will be no insiders with information advantages because prices and share quantities will be broadcast to the world. There will be no insiders with trading advantages because orders will be executed first come, first serve.

In addition, there will be no members. Traders are customers first and last. That means no users will have undue boardroom clout.

CLOB at Heart

The Archipelago Exchange will function much as the Archipelago ECN does today. A central limit order book will form the heart of all trading. Most orders will flow to it and not to dealers as they do on most of the country's seven stock exchanges. Dealers will still occupy a higher standing than other traders, but they will not run the show. In sum, the exchange of tomorrow is the ECN of today.

"Archipelago is all about lowering the barriers to entry for trading securities," said Mike Cormack, Archipelago's president. "We want to make it easy to post a bid or an offer or to reliquify your position. And, if you think you're good at it, to make markets."

The Archipelago ECN is far from the largest ECN. Instinet and Island share that distinction. Archipelago (identified as Arca' on trading screens) runs with a pack of second-tier ECNs that include Bloomberg TradeBook, BRUT, and REDIBook. Daily volume averages between 90 million and 100 million shares, according to Cormack.

Like most of the top six it is backed by well-heeled owners. Wall Street firms with a stake in Archipelago include such heavies as Goldman Sachs and American Century. Among ECNs it is one of three with aspirations to become a stock exchange. Island and NexTrade are the other two.

But becoming a stock exchange is an expensive and time-consuming process. Operating as one guarantees hawk-like scrutiny from the SEC. Archipelago already trades listed stocks through Nasdaq's Intermarket. So why bother?

To abuse an old real estate adage, it's all about Nasdaq, Nasdaq, Nasdaq. Archipelago, like all ECNs, is a member of Nasdaq. It yearns to break free. Unlike Instinet and TradeBook, which consider themselves agency brokers and are comfortable in the Nasdaq fold, Archipelago and Island see themselves as competitor markets.

"This will provide us with a level of autonomy," Cormack explained. "It will allow us to control our own destiny and actually gain revenue from the price discovery process."