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April 30, 2003

A Market Maker Tremor?

By John A. Byrne. Editor

A year ago, market makers were recovering from what some described as a low blow: the introduction of penny pricing. The wounds were caused by the elimination of profitable spreads. Penny pricing was good for you know who - Aunt Nora in Boston - but a dreadful step for institutional traders. For many market makers, the remedial fix was commissions. But it was tough going. For instance, firms had to work out how to charge one side of a trade on a principal basis while the other side was charged a commission. So the results of the 2003 Traders Magazine Annual Survey of Market Makers are important in answering the question that so many in the trading industry are asking: How are market makers holding up?

Not so good and not so bad, as it happens [see inside this issue]. Market makers as a group are a hardy lot. The overwhelming majority polled for this year's survey expect to remain in business, come hell or high water, in the next 12 months. Most predict the stock market will improve. Many say they will hire more pros. And, despite concerns that decimalization would destroy profitability, about 75 percent of market makers tell us they are profit centers. But most agree with the proposition that nickel increments would be a positive step for dealers. Try telling that to the Securities and Exchange Commission. (A most recent Traders Magazine Web Poll, as of late April, generated the same majority response in favor of nickels.)

So a perfectly wonderful picture overall? The fact is this is a most difficult time for many market makers, according to traders. Sure, the business is profitable but barely so in many cases. And ECNs, a group that has legal sanction to charge access fees - fees that dealers have fought tooth and nail- are still eating their lunch. But it is a mixed, if not complex, environment to portray. This is because, in part, there is so much overlapping ownerships in ECNs and dealer firms. And there are unique strategies used in proprietary and other trading that disguise the exact amount of damage to dealers. In other words, as a pure, standalone operation, does it pay a broker dealer to operate a market maker operation? Some dealers have found profitability exploiting various opportunities in mid-cap names. Others have reaped opportunities in Bulletin Board and Pink Sheet trading. And more seem to be making money in algorithmic and program style trading. But overall, it is a mixed picture for market makers. Some are struggling. But there are many dynamic market making players as proven by firms that are reinventing themselves. Some examples include BrokerageAmerica, Knight Securities and Schwab Capital Markets. Many of the best - and the players who try harder - will likely still be with us next year. That is our hope and our prayer.

John A. Byrne