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November 1, 2003

Nasdaq's Electronic Call Auction

By Peter Chapman

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  • Nasdaq's Electronic Call Auction

The OTC Market Has a New Fix for Perennial Problem

Nasdaq, after years of criticism over its scattershot openings and closings, will soon start and end its days with an electronic call auction.

The new system, dubbed Nasdaq Cross, is being built in response to charges from regulators, traders, index providers and academics that Nasdaq's openings and closings produce too many prices, making it impossible to ascertain the true open or close.

Nasdaq Cross will bunch as many orders as possible to produce a price that more adequately reflects supply and demand in a security. The technology, which first will be used to determine Nasdaq's closing price, is scheduled to debut in the first quarter. Then, it is scheduled to be used in the second quarter to calculate the opening price.

"The industry needs a central facility where all the orders can come together in a price discovery process that is truly reflective of the market," said Adena Friedman, Nasdaq's executive vice president in charge of data products.

Nasdaq originally intended to apply the technology to its helter-skelter opening, but quickly changed its plans following a major slap in the face from Standard & Poor's. The indexing giant announced it would stop using Nasdaq's closing prices in the construction of its S&P 500 index and, for a trial period, use those prices from the American Stock Exchange.

The switch could result in large swaths of Nasdaq order flow migrating to the Amex at the close, especially from index traders. That would be a big boost for the Amex's Nasdaq program, which is struggling to win flow.

That the Amex trades a negligible amount of Nasdaq shares was apparently less of a concern for S&P than the methodology of its closing process. Like the New York Stock Exchange, the Amex closes (and opens) with a call auction. The auctions are not electronic, but are handled manually by specialists as is most order flow on the floor-based boards.

A call auction of the sort used by the exchanges brings together all buying and selling interest in a security to derive a single price. Because the auction typically involves a substantial portion of the day's share volume, the resultant price is considered the best indicator of the value of the security at that point in time. The price is said to have "cleared the market."

Nasdaq, on the other hand, does not derive its opening and closing prices by bunching orders. It simply takes the first and last prints of the day, respectively. And, until recently, the trades that led to those prints might have occurred on either Nasdaq's SuperMontage system, the ADF or any of the UTP exchanges.

That policy changed slightly this June-for the closing, at any rate. In a bid to impose order on the chaos, Nasdaq christened the NOCP, or Nasdaq Official Closing Price. Henceforth, only trades done on SuperMontage would be considered eligible as the Nasdaq closing price. Nasdaq will designate an official opening price in January, according to Friedman.

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