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February 1, 2002

Sabotaged By The Enemy? Will Direct Access Eliminate Middleman?

By Brian O'Connell

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  • Sabotaged By The Enemy? Will Direct Access Eliminate Middleman?
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Legions of institutions, led by hedge funds, are taking a straight, speedy, and anonymous path to the New York Stock Exchange and to the major ECNs.

It is a path that many say provides lower transaction costs than the service offered by market intermediaries.

The vehicle is called direct access trading. And its proponents contend that it represents the next generation of online trading.

Nevertheless, its growing popularity may cause problems.

It could crimp business for traders who earn a living through conventional arrangements, according to several experts.

Floor brokers, specialists, market makers, sales traders, all of these intermediaries and more could see direct access encroach on their franchise, these experts say.

"Direct access offers anonymity and institutions love that because they don't want to tip their hand," said John Petschauer, senior vice president at, the direct access unit of Javelin Technologies. "Information comes directly from the point of sale. The institution's name is only given to the third-party clearing firm. It's a pure agency transaction."

One buyside trader, who declined to be named, said he attended a conference promoting direct access services. "We were told our trades would be routed to one execution-only broker," he said. "That definitely cuts into upstairs sales traders relationships and pockets. Trades go right by the desk."

Direct access trading has grown up from a mostly retail, day trader-based technology associated with electronic communications networks, to one that also seeks out fat institutional accounts.

Proponents remind skeptics that, just about three years ago, a small core of market-making firms handled over 85 percent of all the volume in Nasdaq stocks. Now up to 50 percent of Nasdaq volume is handled by ECNs, according to a J. P. Morgan analysis.

Within the next two years, an estimated 75 percent of all institutional trades will be executed electronically, up from 40 percent today and 20 percent two years ago, according to TowerGroup, the Needham, Mass.-based securities industry consulting firm.

"Let's face it, we're moving away from traditional trade brokers and toward direct access," said Jim Valente, managing director at New York-based IDI, Institutional Direct, a provider of direct access services to institutional traders. "It reduces the need for a middleman."

Other providers agree. "Direct Access is coming to the trading floor and market makers will take a hit," contended John Forlines, chief executive at New York-based Blackwood Trading, one of the bigger direct access players. "There's no doubt that the people in the middle are going to have to demonstrate their ability."

However, others say the middleman will adjust, and may thrive in the changes unleashed by direct access. Indeed, part of IDI's strategy, it says, is having its affiliated floor brokers "determine the depth of liquidity and indications of buy and sell interest by talking to the [NYSE] specialist." There is, in effect, an intermediate step, before the final execution.