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February 24, 2006

Philly Moves to ECN Strategy

By Peter Chapman

The Philadelphia Stock Exchange, in a bid to become more competitive, is reshaping its equities business along the lines of an ECN.

"We are moving to an open book, open access model," said Bob Miller, senior advisor to the PHLX. "We will have a new set of trading rules and a new trading platform. We will be completely electronic and fully Reg NMS compliant."

The exchange handles less than 1 percent of all shares traded in the U.S. and considers its specialist-driven model to be out of date. The overhaul is meant to draw in new players and order flow.

That, the PHLX believes, will lead to a boost in its market share: "We anticipate having a significant presence in the equities market," Miller adds.

The exchange hopes to complete its overhaul by the time the Securities and Exchange Commission's new Reg NMS trade-through rule goes into effect in June.

The rule, approved last year, is forcing the nation's stock markets to invest in technology to make their quotes instantly accessible. Those quotes that aren't fast' on June 29th can be ignored.

About 95 percent of the PHLX' incoming orders already receive automatic executions against specialist positions through the PACE order management system. Liquidity at the exchange, though, is scant.

"Even though the executions are automated," Miller explained, "you don't get the interest in the Philly that you might have if you had more people playing."

Last summer, Merrill Lynch, Citadel Derivatives Group and other firms invested in the Philadelphia to support its booming options business.

Although the investments were not earmarked for the equities operation, the PHLX views its new partners as a marketing opportunity in equities, according to Miller.

The PHLX proposal, not yet finalized, removes the specialist from the order-handling process. It allows all types of traders to make markets on an ECN-like display book.

With that set-up, the PHLX hopes to attract auto-trading black-box shops. Its current model discourages their participation. Specialists-who control all of the incoming orders-don't want to trade with black boxes.

To accommodate the change, the PHLX is building a new trading platform from scratch. PACE will be scrapped. The PHLX is not adapting its XL options trading platform to equities.

Will the new platform give certain players special privileges? Miller will neither confirm nor deny. The issue is a sore point at other exchanges undergoing revamps.

Miller does note that the PHLX will not incorporate circuit breakers that abort auto-ex if stocks move too far, too fast. That is an element of the Big Board's hybrid plan. The PHLX, which will close its floor when the new trade-through rule goes into effect, supports six specialists.

At least one, Joseph Carapico, of Penn Mont Securities, says he is aware of the new trading platform, but not the pending changes to the PHLX' business model.

"I received verbal notification of the change last December," he said. "I have heard nothing further." The PHLX hopes to file its rule changes with the SEC soon, according to Miller.