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BNP Asset Management's Pojarliev discusses a variety of options to address foreign currency exposures. Although there is no single best-practice solution for addressing foreign currency exposures, institutional investors have three main choices, he says.

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April 30, 2002

Light at the End of the Tunnel...

By John A. Byrne

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Some market makers, bruised by regula tory changes and a horrible stock market, may finally see light at the end of the tunnel. It's still too early to pop open the champagne, but dealers are changing course, hoping market making will soon emerge from the dark tunnel.

"Costs are up and profitability is down. The changes are forcing dealers to take a new approach," said John McFarland, head of Nasdaq trading at Ladenburg Thalman & Co. in New York. "You can't make money on a spread in an environment with 100-price points. More and more dealers are moving to agency trading."

That includes Ladenburg, a small New York-based market maker ranked No. 60 by Nasdaq. Like others, Ladenburg has grafted an agency-arrangement on institutional orders. For Ladenburg, that's especially significant. In recent months, it has gradually added pros, building up its institutional trading desk. Total headcount on the desk, which also handles retail and broker dealer business, is 17. "We've grown our institutional desk staff by 200 percent in the last two months," McFarland said.


Big dealers are among the most significant players moving to commission business, reducing their volume of spread, or net-based trading. That's because these dealers are much less willing to put up capital in a penny environment to complete large orders for institutions. It is riskier than the old teeny environment.

Indeed, of the top 25 Nasdaq dealers, 70 percent of all their institutional trades are conducted on a commission (or commission equivalent) basis, according to this year's Traders Magazine Survey of Market Makers.

The rollout of commissions is a gradual, even tedious process that requires technology to implement. Firms still have to work out how to charge one side of a trade on a principal basis while the other side is charged a commission. "The client-to-client hybrid is one problem, but it will disappear as firms move to commission-only business," predicted Brian Pears, the head of equity trading at Victory Capital Management in Cleveland. "The other hybrid - giving one client a confirm showing that a broker acted as both agent and principal - will be with us for a while. It's likely more profitable for a market maker to act in both capacities on the same trade."

However, this type of transaction is not exactly new. "If I call a firm with 200,000 IBM to buy and they short me the first 50,000, they've essentially done the same thing," Pears said

Either way, agency trading is welcomed by large mutual funds and others on the buyside. In part, this is because agency trading allows institutions to clarify commission charges on the confirmation slip. This is in keeping with the spirit of new trade disclosure rules.

Some dealers are taking special steps. For instance, Goldman Sachs provides "recaps" - order execution summary reports - to clients, breaking down all the prints that constitute an average price execution. Each time Goldman buys or sells stock for an institution, it will disclose whether it acted as principal, agent, or both.