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November 1, 2003

Is the Specialist System Doomed? With Dick Grasso gone,more trouble is brewing for NYSE specialists

By Steve Watkins

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  • Is the Specialist System Doomed? With Dick Grasso gone,more trouble is brewing for NYSE specialists
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Can it get much worse than this for NYSE specialists? Plunging profits, declining revenues and regulators investigating how specialists conduct their affairs. And all this is happening at the same time that the Big Board is punishing five specialist firms for unethical trading.

It's ugly.

The difficult times only worsened when the New York Stock Exchange conceded that seat value had dropped by 27 percent over the last month. A seat recently fetched a price of $1.35 million.

But the woes don't stop there. With the ouster of NYSE Chairman Dick Grasso, some buyside pundits and others are hoping the interim exchange head, John Reed, will push for a radical overhaul of the NYSE specialist system. These critics want faster executions and the elimination of barriers to outside competition.

Among an influential cadre of buysiders calling for reform are traders at Fidelity Investments, T. Rowe Price and American Century. At Fidelity, Scott DeSano, the mutual fund giant's head of global equity trading, said that the current specialist system should be scrapped.

Buyside Chorus

Joining the buyside reform chorus is a plethora of ECNs and other electronic trading systems. Direct access brokers, for instance, have in recent years muscled in on the floor business. Today, these electronic players, who bypass upstairs desks, handle an estimated 30 percent of listed volume.

To hear buysiders and officials of ECNs tell it, the battle is practically a fight between good and evil. Buysiders, however, frequently cite the nimble technology and speed of executions on electronic platforms. Some officials of electronic platforms put it in terms of customer fairness.

"The specialists create an inherent conflict of interest with the customer," said Seth Merrin, CEO of Liquidnet Inc., a New York-based electronic match maker that handles listed business in an anonymous environment. "Why is that middleman necessary?"

An executive at one ECN complains that the NYSE, which has spent millions of dollars on technology, still lags behind Nasdaq on a variety of measures. "Some institutions believe it's more efficient to trade on Nasdaq than on New York," said Sanjiv Gupta, the director of research and strategy at Bloomberg Tradebook ECN.

Specialists beware? Sure, an overhaul could reduce the clout of the specialist community, a collection of some 440 individuals managing 2,800 stocks. But this overhaul may not happen as fast as critics would demand. And the reforms may not be extensive, note some experts. That's because the tight-knit specialist community still has many defenders.

One specialist, acknowledging that some reform is needed, has come out swinging. "In my opinion, the specialist system is the best system to execute trades, when it's done properly," Michael LaBranche, CEO of LaBranche & Co., told Traders Magazine. "But we can't lose sight of the fact it needs to keep improving."

Here is what LaBranche and other floor members recommend: giving investors greater ability to cross stocks, more transparency, even more automation while allowing institutions to access the NYSE auction market without getting trades broken up.

The New Era