Commentary

Elaine Wah

Modern Markets, Modern Metrics - A Blog By IEX

In this blog by IEX's Elaine Wah, the newest public exchange looks to refute public claims that the metrics it uses are designed to inflate its own volume numbers and mislead people.

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May 26, 2005

More Surprise! Surprise!

By John A. Byrne

In recent years the question persists: What is a Nasdaq and OTC market maker? It was an easy question for Traders Magazine in a bygone era. But with the eclipse in the traditional role of the market maker, there is a certain hesitation lately before answering. Nevertheless, by definition, the market maker is alive and well, even though at some desks his or her functions have been melded together with other areas. The dealer is said to perform much more agency transactions. The golden years of trading net and committing capital are history. Still, in this issue Traders Magazine received plenty of responses to its Annual Survey of Nasdaq/OTC Market Makers. In the purest sense, the last bastions of the OTC market are the Bulletin Board and Pink Sheets. But it would be wrong to dismiss the market maker function as irrelevant, notwithstanding the glorification of the agency model with Nasdaq's recent INET transaction. Sure, market makers have surrendered much control to the buyside. But market structures are so dynamic, that the latest hot thing - the algorithmic trade - could, in an odd twist of fate, be superseded one day by market making. Nothing seems impossible in market structure. Who, for instance, would have thought that Nasdaq would one day have its own trade-through rule? This controversial Reg NMS change is aimed at curbing trade-through abuses in one out of every 40 Nasdaq trades. That's about 98,000 trades daily, according to the Securities and Exchange Commission. But the SEC's idea with this "Order Protection Rule" has more to do with regulatory consistency in both listed and Nasdaq markets. That is important as Nasdaq market participants, including speedy ECNs and ATSs, compete for more listed stock orders.

Manual quotes are not protected under the rule. Neither are block orders and small quotes exempted. But this set of changes don't amount to much, according to Celent Communications. "The only real impact of this rule change on Nasdaq is that it will have to spend a modest amount of resources to establish compliance and enforcement programs," Celent notes. Several trading pros expressed disappointment about the new trade-through rule. But some saw the benefits in other parts of the Reg NMS reform package, which includes intermarket access, subpenny quoting and market data. However, the trade-through changes are debatable. Indeed, Celent says that institutional traders could find it "more difficult to hide in black-box trading platforms and/or find natural buyside counterparties, which will result in increased frustration, increased market impact, and higher execution costs." On the other hand, this might be welcome news for institutional brokers, "who have suffered because of the buyside perception that they cannot always be trusted, but this is certainly an optimistic view," according to Celent. Nothing can be ruled out in these markets.