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September 28, 2006

Nasdaq Plans to Rank Brokers' Proficiency in Market Making

By Peter Chapman

Also in this article

  • Nasdaq Plans to Rank Brokers' Proficiency in Market Making

Nasdaq market makers are wary about a new Nasdaq initiative to rank them.

The stock exchange will launch its "Select Market Maker Program" this month, with the stated goal of rewarding those dealers who consistently outperform their competitors in quoting and trading.

Nasdaq's plan is to produce a database of the "best" market makers in all securities traded on its system. The information will ostensibly assist order senders and stock issuers choosing a broker-dealer.

Market makers could win more order flow from institutional customers and possibly help their investment banking departments win more mandates, Nasdaq officials maintain.

Nasdaq also believes the program will produce a better quality market overall, execs there say, because spreads will tighten and quoted size will increase.

To be considered "select," dealers must meet Nasdaq's standards in their quoting (tighter spreads and more size) and trading (share volume thresholds).

The details of the criteria were not public when Traders Magazine went to press. But the idea of Nasdaq passing judgment on dealers' trading practices still troubles some of them.

"It's a dangerous game when an exchange starts trying to decide the categories that determine best execution," notes Mark Madoff, an executive with wholesaler Bernard L. Madoff Investment Securities. "Nowhere in their criteria do they look at the price of an actual execution."

Others say that supply and demand should determine the levels of market maker quotes and trades, not Nasdaq. These execs find it odd that Nasdaq would encourage dealers to quote and trade more aggressively even if unwarranted by market conditions. That could increase their risk and cause them to lose money.

"Am I going to continue to be a market maker?" asks one exec rhetorically. "No. I'm going to drop the stock. Nasdaq will end up with fewer people making markets. Is that what they want?"

Nasdaq's Brian Hyndman, senior vice president of transaction services, says he does not expect market makers to try and get on the list if it means they will lose money.

However, he does believe that "true" market makers will tighten their spreads and increase their sizes under the program. "The quality of the market will improve," he added. "It will become a more competitive market."

Indeed, sources say, that is the likely endgame. Better market quality statistics will give Nasdaq ammunition in its war for market share with the New York Stock Exchange.

For years, Nasdaq and the NYSE have wrangled over which organization runs the better marketplace, using statistics to back up their claims.

Nasdaq execs concede that institutional traders do have an array of data at their fingertips when deciding where to send their orders.

But their stats, Nasdaq maintains, will paint a better picture of a market maker over time and distinguish between a true market maker and a "fair weather" market maker.

Reaction from other traders was more muted. Some don't expect much of an impact on their operations from the program. "It's not a net positive," says one head of Nasdaq trading at a small broker-dealer, "but I don't see much coming out of it either way."