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September 28, 2006

Exchanges Say They Have Better Linkage Plan

By Gregory Bresiger

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  • Exchanges Say They Have Better Linkage Plan

Private exchange linkages, designed and paid for by the exchanges as they use them, are better routers than the current Intermarket Trading System (ITS).

That's the thinking of officials of eight major stock exchanges, plus the Chicago Board Options Exchange. So they have submitted a temporary Reg NMS linkage plan to the Securities and Exchange Commission.

The proposal still requires the exchanges to accept orders over the legacy ITS system, but it allows them to route over their own proprietary linkages. The plan is designed as a bridge from ITS to the more electronic markets that will be in force when Reg NMS's trade-through rule is finally implemented. That is scheduled for next year, sometime after this temporary plan expires.

"Some of the participant exchanges are already in the process of utilizing proprietary linkages in place of the ITS system," said a spokesman for the Boston Stock Exchange, one of the members of the plan.

The much-maligned ITS is both a routing network and a set of rules supported by a consortium of exchanges. But Nasdaq officials, in pulling out last year in favor of private linkages, complained that the ITS is slow and lacks capacity. Other trading officials have charged the ITS is long in the tooth.

Born in 1978, ITS was set up to ensure that a stock would fetch the same best price across different exchanges. But ITS is attuned to a world of manual trading that is disappearing with the rollout of Reg NMS and the appearance of new, easier-to-establish private linkages, trading executives say.

Private linkages are technically and operationally more efficient than the ITS because they are controlled by the individual routing party, Chris Concannon, executive vice president of Nasdaq Transaction Services, told Traders Magazine.

"The ITS linkage is technically controlled by SIAC (Securities Industry Automation Corporation) and run by the ITS committee. Private linkages allow a great deal of flexibility with respect to order types," he said.

One trading executive at an electronic firm complained that the ITS system is inefficient. The ITS, he added, was set up by the NYSE in coordination with regulators and lawmakers at a time when the New York Stock Exchange's auction model dominated the trading industry.

The executive, who declined to be identified, also complained that access to the ITS system was often free. That meant the ITS was poorly run, bureaucratic and inferior to bilateral linkages set up by trading players in electronic markets, he said.

"This is a confirmation of the superiority of the private linkages model used by Archipelago back in 1999, which was better than the quasi-government ITS linkage plan," said the trading official. "That system was set up in 1999, at a time when some exchange officials couldn't spell the word linkage.' "

Under the new Reg NMS linkage plan, each participant "is required to bear 100 percent of the costs to provide communication connection from the participant's facilities to the system's communications maintained by Securities Industry Automation Corporation," according to the plan. Production costs must also be borne by each participant.

The new NMS linkage plan is to operate until next fall, when Reg NMS is scheduled to be fully implemented. Reg NMS permits exchanges to build private linkages.