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January 1, 2004

Breaking Instinet in Two

By Peter Chapman

Despite the increased institutional presence, it has only been in the past few years that Instinet has taken any steps to physically separate its front-end brokerage services from its back-end processing. Instinet didn't even begin to acknowledge it had sales traders until recently.

Given the hefty pricing disparity between buyside and sellside customer orders, the decision to split the company is perhaps inevitable. That's because the split frees the more profitable agency brokerage from the confines of its relationship with the struggling ECN. Certainly, the agency brokerage has the most to gain while the ECN has the most to lose.

INET loses a near lock on the approximately 90 million shares per day handled by the institutional brokerage. The brokerage, on the other hand, by severing its tie to INET, loses less than it would have a few years ago. Nowadays, any broker, alternative trading system or front-end vendor can access INET's full depth of book. Until recently, only Instinet customers could do so.

That means it is no longer imperative for the buyside to have a relationship with Instinet in order to access INET. The value of that tie has already diminished.

The Benefit

Breaking the company in two to benefit the brokerage looks smart if there is even the possibility the ECN is holding the brokerage back. As a stand-alone entity, the brokerage does not have to try to balance the needs of INET with those of its customers. The split eliminates the real or perceived conflict of interest.

For instance, the agency brokerage used to dump all orders over which it was given trading responsibility onto the ECN. Now its sales execs can assure buyside traders that won't automatically happen.

Although that pool is one of the four biggest in the Nasdaq world, it is also populated with a lot of sharks: broker dealers looking for meat in the form of information and a fast buck. "That pool was, in some ways, a dangerous place to play," Natan Tiefenbrun, co-president of the institutional brokerage, told Traders Magazine.

Some have speculated that Nicoll is positioning the ECN for a spin-off. Nasdaq is usually mentioned as a possible buyer. Is that the case? "No," Nicoll said simply. That the question gets asked reflects the difficult operating environment of electronic execution venues. Besides INET, there are three other significant players - SuperMontage, ArcaEx and Brut. All have been bloodied by price wars in the past two years. Yet, all are hunkering down for a fight to the finish.

The Migration

INET is the result of the "merger" of the Instinet ECN with the Island ECN, purchased by Instinet in 2001. As Traders Magazine went to press, all orders on the Instinet ECN were being migrated to the Island ECN. The company chose the Island platform because it is newer and dedicated to order matching. The much older Instinet platform is more complex and sprawling, according to INET President Alex Goor.

Cost is everything in the ECN world. So, to save on rent, the INET group is moving to New Jersey. The team of 75 employees is moving out of Instinet's modern Times Square office building, with its stone-and-glass curtainwall exterior directly across from Nasdaq, to Jersey City.