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June 6, 2006

NYSE's Hybrid Approval Stirs Buyside Concerns

By Gregory Bresiger

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  • NYSE's Hybrid Approval Stirs Buyside Concerns

The Securities and Exchange Commission gave it the green light, but some on the buyside are still grumbling.

Two years and eight amendments after it was proposed, NYSE Group's hybrid market plan won SEC approval. The new market structure for NYSE Group's New York Stock Exchange subsidiary is scheduled to be fully operational by the end of next month.

The blend of automated and human trading "should provide investors with a more efficient mechanism to have their orders executed on the Exchange," the SEC stated in its approval order.

The regulator also believes the hybrid will offer traders faster access to NYSE quotes and "could enhance the opportunity for a customer's order to be executed without dealer participation."

Such happy talk did not ring true to many of the New York's critics.

They warn that they will be hesitant to use the new Big Board because of the privileges to view orders given to specialists, and, to a lesser extent, floor brokers.

They argue that NYSE specialists will "disincent" the placement of public limit orders.

"Who will want to enter a fully-displayed limit order," one buysider asks, "that attracts contra-side liquidity, only to have, particularly in sweep transactions, a hidden order entered later in time grab the execution and shut out the displayed public limit order?"

Nevertheless, defenders of the hybrid plan, conceding that it gives specialists advantages, argue it is justified. That's because it means the NYSE will offer more effective price improvement at the same time that it preserves specialist firms, hybrid defenders say.

"The NYSE has enhanced the ability of the specialist to make money, but only by the specialist providing value-added services," said an official of a specialist firm who didn't want to be quoted by name.

Still, the changes in the hybrid plan will hurt clients and obligate traders to seek other trading venues, critics insist.

"The hybrid may be a great place to hit and take liquidity, but it will not be a good place to post. It will become an execution venue of last resort," warned one buyside trading official, who declined to be quoted by name.

The NYSE, in the eighth amendment, wanted to save the specialist position. So Big Board officials proposed to permit specialists to participate electronically in the hybrid market.

An example of this is providing specialists with information about incoming orders before they are processed by the Display Book system. Using their own algorithm, specialists would be able to make limited quoting and trading decisions in response to incoming orders. These would include providing "price improvement, improve the Exchange BBO, or supply size to fill the incoming order at the Exchange BBO," according to the eighth amendment.

In a comment letter and an interview with Traders Magazine, one prominent critic contends the SEC made a Faustian bargain.

"Why were specialists the big winners here?" asked George Rutherfurd, a Chicago-based consultant to two trading organizations.