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February 24, 2006

Handicapping 2006: Coming stories of this year

By Jamie Selway

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  • Handicapping 2006: Coming stories of this year
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With the New Year comes the usual punditry and prognostications, and the fast-changing exchange and brokerage landscape is no exception. Below are eight market structure predictions for 2006.

Nasdaq's Share of Listed Trading Beats NYSE's Share of Nasdaq Trading. Armed with technological advantage, strategic clarity, and a new pricing proposal, Nasdaq makes significant inroads into listed trading. At year-end, Nasdaq has 35 percent of the listed tape.

NYSE Group, via Archipelago, benefits from the Inet-BRUT-Nasdaq integration but loses the short sale advantage, and ends the year flat at 20 percent of the Nasdaq tape. Barring a roaring bull market, listed volumes grow 50 percent as the marketplace goes electronic. The 200 percent to 300 percent increases that some foresee fail to materialize.

NYSE Builds Hybrid, Doesn't Fully Implement. In spite of its costs and lukewarm reception, the NYSE spends the first half of 2006 building the Hybrid market and rolling it out piecemeal. By late summer, with Nasdaq gaining share, Reg NMS delayed (see below), and shareholders nervous, NYSE CEO John Thain pulls the plug.

With Archipelago in its back pocket, the Exchange opts for side-by-side trading (a la CME), rather than going forward with a third "compromise" system to bridge the gap. By year-end, NYSE Hybrid joins OptiMark and AZX on the ash heap of history.

Reg NMS: "Nothing Done." Until a new pilot takes the helm, the SEC's Division of Market Regulation struggles to implement the should-be-simple elements of Reg NMS, such as subpenny trading. As the issue of trade-through reform approaches, the complexity of guidance and cost of compliance grows substantially.

Moreover, the fact that both major marketplaces are now for-profit, publicly-traded companies raises the stakes in ways that the SEC didn't anticipate. The bulk of Reg NMS is therefore punted to 2007. Quietly, the new SEC leadership begins to question the wisdom of moving forward at all.

BeX and Phlx Disappoint; BATS and DirectEdge Surprise. While the bulge bracket investments in the Boston and Philadelphia Stock Exchanges created buzz in 2005, they'll largely disappoint as practical equity propositions in 2006. Instead, two dark horses-TradeBot's BATS and Knight's DirectEdge-provide competition to the Nasdaq/NYSE "duopoly." Knight rolls its own orders into DirectEdge in early 2006, creating a sizeable pool of liquidity.

BATS launches in April or May with top-shelf technology and utility-style pricing, and garners share from quantitative trading types. Additional announcements of re-habbed regional exchanges hit the tape, but BATS and DirectEdge prove the ones to watch.

Path to Pennies Emerges for Options Markets. Over the past few years, via BOX's PIP and ISE's PIM (and now CBOE's AIM), the options markets have played footsie with penny-based trading. Technologists warn of exploding data; options market makers claim pennies cause cancer. But the fact remains that nickel- and dime-based options markets are much too expensive for many investors. An enterprising exchange or two realizes this and proposes to quote and trade options in pennies on a pilot basis. Contention over the proposal consumes most of 2006, but by year-end approval is secured for implementation in early 2007. (And once implemented, volume in liquid contracts grows significantly as investors respond to reduced trading costs.)