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May 26, 2005

The Amazing Loss of Control: Pushing the sellside around?

By John A. Byrne

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  • The Amazing Loss of Control: Pushing the sellside around?

The tide is turning for Nasdaq, the electronic stock mart that once got whipped so badly by regulation, ECNs and a brutal market, that it seemed close to drowning in a sea of red ink. Now it is back playing in the big leagues again, having signed a deal to acquire INET from Reuters in a $934.5 million transaction for Instinet that had an overall value of $1.9 billion. The deal is expected to take about six months to close.

So, with this giving Nasdaq a market share of perhaps between 65 percent to 75 percent in the trading of its own listed stocks, more bells and whistles and places to cut overlapping services, what does it do for the very foundation stone of this once quixotic marketplace? Wither the Nasdaq market maker?

If you listen to Nasdaq CEO Bob Greifeld tell it, the Nasdaq market maker has never been as important. Greifeld recently spoke of an "all-time high" mutual respect between Nasdaq and the market makers. "Clearly, they are the backbone of the Nasdaq Stock Market," he told Traders Magazine last month. "They have been since its inception, and in this decimal world in which we live, the market makers have done a remarkable job of transforming their business models."

Some of the market marker desks polled for the 2005 Traders Magazine Annual Survey of Nasdaq/OTC Market Makers return the compliment. However, 33 percent feel that Nasdaq management is taking positive steps for the dealer community. The same percent disagreed, while a similar percent had no opinion. Still, the response rate does not reflect the views of a diverse group of trading pros, including dealers, who have in recent weeks privately praised Greifeld.

At the same time, this is a much-changed environment from the days of fractional trading. That's when the term market maker had a precise meaning, a desk that posted two-side continuous quotes, committed capital and made money on the spread. Heavy losses were not uncommon. But it was generally a profitable era for many market makers. Some of that still exists in pockets, especially in the OTC Bulletin Board and Pink Sheets. However, most of the OTC order flow today is coursing through a galaxy of pipelines - algorithmic, direct access, crossing networks, ECNs and other machines. It is difficult to completely quantify how, in fact, most orders are exactly handled. By one rough estimate, some 75 percent of equity order flow today is handled through computerized models. And algorithmic and programmed trades are as pervasive as the VWAP, TWAP and the exotic algo strategies used by institutions.