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October 19, 2006

Vying to Become the Next ITS

By Peter Chapman

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For the past couple of years, equity trading technology staffers at many broker-dealers have been gnashing their teeth and tearing their hair out over the myriad technical challenges presented by Regulation NMS. But in Princeton, N.J., at the headquarters of Order Execution Services Holdings, the only frustration has been over the delay in the implementation of the Securities and Exchange Commission's sweeping new rule.

The centerpiece of the new regulation, the order protection and the fair access rules, is like a gift from the gods for the small, specialty broker.

OES, which operates an extensive network used by broker-dealers to send orders to exchanges, suddenly finds itself at the center of the NMS whirlwind. Literally.

"With Reg NMS," says Michael Barth, an OES senior vice president responsible for exchanges and market centers, "we've positioned ourselves to be the premier private linkage provider for the exchanges as the alternative to the ITS."

The ITS, or Intermarket Trading System, is the network operated by the Securities Industry Automation Corporation that transports orders between exchanges. The technology and governance of the 30-year-old ITS are supported by all of the nation's stock exchanges. With the coming of Reg NMS, though, ITS is scheduled to be phased out.

In its place, exchanges intend to handle their own outbound routing, relying on internal resources or contracting with specialty broker-dealers and/or vendors.

Under Reg NMS, exchanges are required to make sure they have the capability to route out orders that do not execute on their trading platforms.

To do so, they need an affiliation with a broker-dealer and an outbound routing mechanism. Some exchanges are setting up the broker-dealer internally and outsourcing the routing. Others are outsourcing both services.

The Prize

At stake are tens, if not hundreds, of millions of shares per day flowing through the intermarket system. OES would take a fee for every share delivered.

However, the profitability of all that flow is a question mark. Some predict a price war once Reg NMS is fully implemented and a dozen or so exchanges and ECNs are competing for flow. The less they get per share, one exchange official argues, the less available for the outbound routers.

OES is one of only three firms under consideration by the country's 10 stock exchanges to provide the broker-dealer services, the routing or both. Lava Trading and Selero, formerly IBSN, are also being considered, sources say.

The firm is positioning itself to act as both a broker-dealer-with representation on all stock exchanges-and a routing provider.

OES has landed five exchanges so far. It will function as the facility broker-dealer and routing supplier to both the Philadelphia Stock Exchange and the ISE Stock Exchange. It will function only as the routing supplier for Nasdaq and the two exchange subsidiaries of NYSE Group.

For them, OES will not act as a facility broker. Nasdaq will use Brut for this purpose. The NYSE exchanges will both use Archipelago Securities.

Lava has two wins: the Boston Equities Exchange and the National Stock Exchange. Still in contention are the American, the Chicago and the CBOE stock exchanges.

"We won't get everybody," says OES chief executive Dave Scheckel, "but we'll get the lion's share."

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