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February 1, 2005

More NYSE Volume, Smaller Market Share?

By Gregory Bresiger

The NYSE's proposed hybrid model - and its Reg NMS restructuring - would result in more automation, bigger volume, but ultimately a decline in the Big Board's market share, according to Chris Concannon, Nasdaq's executive vice president for transaction services.

"What you're doing is eliminating friction in the market center and promoting increased transaction activity. The by-product is increased volume," Concannon told Traders Magazine.

Concannon said volume had gone up in Nasdaq, as well as on options and futures exchanges, with the use of more automation. He also believes the absence of a trade-through rule promoted innovation on Nasdaq. But on the Big Board, trade-through rules have stifled competition.

Concannon, referring to the NYSE's huge listed business, said that all electronic exchanges have a sort of natural cap to their market share. "And while I'm not sure what that cap is, I'm almost certain that it is not 80 percent." He said that concentration of equity order flow inevitably leads to the use of multiple automated venues. "This protects the big order flow providers from pricing power and system dependence." He added that these big firms do not want to be dependent on one destination because of the potential for breakdowns.

Indeed, Nasdaq itself eventually lost its monopoly market share to a variety of ECNs and electronic competitors when the Securities and Exchange Commission's order handling rules made it easier for investors to post limit orders away from market makers.

Nevertheless, intermediaries, such as floor brokers and specialists can, at times, provide valuable services, Concannon says, but they must evolve as markets automate. They are very similar to institutional agency traders on the Nasdaq side. But this kind of business - as markets become more automated - is moving toward "the low touch, small order sizes because you can do that business anonymously." He added that broken up orders are "much more receptive" to an electronic model.

One senior executive at an electronic brokerage concurred. "Once the NYSE becomes a more automated market and trade-through is reformed, sophisticated computerized firms like Automated Trading Desk and Lime Brokerage, for example, will start posting more two-sided markets in listed stocks," said the executive, who declined to be named. "These and other firms will contribute substantial liquidity in listed trading but yes, ultimately you will see NYSE's own market share erode."

Concannon also said the fast/slow market approach is at the heart of the Reg NMS debate. He predicted that a modified version of the Securities and Exchange Commission's proposed Reg NMS will be passed this year.