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February 16, 2007

Big Board Loses Edge As Price Improvement Drops

By Peter Chapman

The New York Stock Exchange, in a development that could dull its competitive edge, is starting to look more like an electronic communications network.

With the number of automatic executions growing under its hybrid marketplace, the Big Board is "price- improving" incoming orders much less often, a new study discovered. The decrease brings the frequency of price improvement at the exchange down to the levels of an ECN.

The study, covering the first eight weeks of trading under hybrid, was authored by analysts at agency brokerage UNX.

It warns that Big Board specialists will need to increase the frequency with which they price-improve orders if the exchange wants to stand out from the crowd.

"Every stock that has gone hybrid has changed its trading characteristics overnight to look exactly like an ECN stock," says Michael Rosen, a UNX trading strategist and co-author of the report. "That means that the classical definitions of the listed and over-the-counter market are disappearing."

UNX examined all of its trades of fewer than 1,000 shares for the first 11 months of last year. It specifically looked at the levels of price improvement granted by NYSE specialists, ECNs and electronic market makers.

The study defines price improvement as occurring when a customer receives a price higher than the market's best prevailing bid when selling and a price lower than the market's best offer when buying.

The study found that in November orders for non-hybrid stocks were price-improved 41 percent of the time. Orders for hybrid stocks were price- improved only 16 percent of the time. At ECNs, the rate is 10 percent.

The study cautioned that the changeover to hybrid was still recent and that specialists could still adjust their algorithms to increase the frequency with which they provide price improvement.

But "if the NYSE hybrid marketplace simply mirrors price improvement at ECNs, it will be quite vulnerable to competition from ECNs and alternative pools of liquidity," the authors reported.

The NYSE would not comment. Other sources noted, however, that price improvement is still available on the floor through the services of a floor broker.