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February 2, 2006

Future Shock Expected to Shake Equity Trading in 2006

By Gregory Bresiger

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  • Future Shock Expected to Shake Equity Trading in 2006

Fragmentation, technology upgrades and the implementation of new regulations covering issues ranging from commissions to a new trade-through rule top the list of trader concerns in 2006, several executives told Traders Magazine.

As regional stock exchanges adapt to the new Reg NMS trade-through rule, fragmentation will raise new questions about how and where to obtain best execution. Reg NMS-the greatest series of market structure changes in some 30 years-has left many market participants anxious but in an anomalous situation.

Indeed, John Wheeler, vice president and director of U.S. Equity Trading with American Century, said, "there is concern about Reg NMS and how it will go into effect. Traders want to know how it will change the buyside's role and how they will compete."

They want Reg NMS to go into effect as scheduled this summer so they can finally have regulatory certainty, explained one buyside executive. On the other hand, traders fear they will misunderstand many of the complex new rules.

The reality of the new Reg NMS environment is that all markets will have to be fast markets, say traders. Top-of-book protection will be provided in the new Reg NMS environment. That means one will not be able to trade through any of these venues. The issue, according to Greg Tusar, head of U.S. Electronic Trading at Goldman Sachs, is how to handle limit orders that need to be posted rather than passive market orders.

"How can you spread those out to ensure that you cover as much surface area as possible because those orders may be in multiple places?" Tusar asked at a recent press briefing. The goal, he adds, is that these orders should be in as many places as possible.

Faster traffic now means the more places a bid is posted, the more likely one will obtain an execution. That will increase message flow and lead to a "dramatic increase in event rates post NMS both in quotes and transactions," according to Jana Hale, managing director and head of global algorithmic trading with Goldman Sachs.

It will likely become more and more difficult to find the right market center because there are more choices as regional exchanges consider creating their own ATSs.

So it is likely that there will be more algo development, or smart order placement development, which tries to minimize the problems of fragmentation, according to Hale

Traders will have to find liquidity in more effective ways. "The next generation [of algorithms] will be more intelligently posting liquidity and making best use of the different venues to maximize execution rates under NMS," Tusar said. But whichever technique is employed, it comes down to finding liquidity.

"Historically the buyside has gone to the sellside to find out where liquidity lies," said Mark Madoff, an executive with Bernard L. Madoff Investment Securities. "Now the sellside has become less and less important to the buyside, which has more and more choices," according to Madoff.

Before NMS it was a relatively easy choice to send orders to the Big Board. But now with Reg NMS there will many top of book selections.