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August 9, 2006

Hybrid Clean-Up' Feature Never Sees Light of Day

By Peter Chapman

The New York Stock Exchange's hybrid marketplace is starting to look just a little more like an ECN.

In response to trader complaints, the Big Board is ditching a key design feature of its new half-manual, half-electronic business model.

Incoming orders that sweep its book at various price levels will no longer fill at just two prices: the market's best price and a so-called "clean-up" price. Instead, they will execute at each price they sweep.

The move by the New York comes after traders said they would not sweep the book if their executions were to bypass several price points.

"This is a positive development," Kyle Zasky, president of institutional brokerage EdgeTrade, said.

"We were not going to encourage our clients to put in these sweep orders if they were not going to get the advantage of all the pricing in between the market and their limit."

The New York's original plan would have differentiated trading on its book from trading on an ECN partly by use of the clean-up price.

Rather than allow less-than-best-priced limit orders to trade at their posted prices as on an ECN, the New York offered limit order traders the possibility for price improvement.

Under the clean-up pricing scheme, an incoming order might sweep a range of orders before filling. The price of the final order swept was termed the clean-up price. The incoming order would execute at just two prices: the market's best price and the final clean-up price.

Those displayed limit orders priced worse than the best price, but better than the clean-up price, would execute at the clean-up price.

They would, in effect, receive price improvement. The plan was an attempt to mimic electronically the way trading is done on the floor of the exchange.

A sell limit posted at $20.10, for instance, when the best offer was $20.05, might trade at $20.15 if an incoming buy order swept up to $20.15.

That might be good news for the limit order, traders told the exchange, but not for the incoming order. The buyer in this example would pay more for his stock.

Traders told the New York they wouldn't use this sweep functionality. They would "walk the book" instead, or pick off each price level with individual orders.

"Rather than build a product that is not responsive to customers needs," the New York said in a recent memo, "the NYSE is redesigning the hybrid market sweep."

The changes will also result in a simplification of the hybrid's circuit breakers, which are known as liquidity replenishment points (LRPs), according to the Big Board. There are two LRPs now. They will be merged into one.