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March 15, 2007

Another Bullseye?

The National Stock Exchange Hopes What Worked Before Will Work Again

By Peter Chapman

It worked once. Will it work again?

The National Stock Exchange, newly re-energized by Regulation NMS, is looking to its recent past for its strategy going forward. As it did five years ago, the National (then known as the Cincinnati Stock Exchange) is embracing ECNs and the market data revenues they generate as a way to profit in an overcrowded exchange space.

While most of the country's 10 stock exchanges view ECNs as threats, the National figures servicing them is a golden opportunity. The exchange has already made great strides in executing its plan, and has earned the envy of some of its competitors. But its success is not assured. Customers and prospects are playing hard to get, while the competition is catching up.

"We want to be the aggregator of the ECNs," says Joseph Rizzello, chief executive of the National Stock Exchange Inc. and chairman of NSX Holdings. "We have decided to be the place where they can both quote and print."

Rizzello, a 37-year industry veteran, replaced David Colker as chief executive of the National last October. Formerly an adviser to the exchange, as well as a top executive at the Philadelphia Stock Exchange, Pershing Trading and Vanguard, Rizzello runs the 50-person National operation out of Jersey City. The headquarters and half the staff remain in Chicago.

Fast Market

Catering to ECNs was not the exchange's original game plan for a Reg NMS world. After the Securities and Exchange Commission recast the marketplace as an electronic bazaar with Reg NMS, the National sought only to become a fast electronic market.

It jettisoned its traditional specialist model and adopted strict price/time priority supported by a new matching engine called Blade.

The problem is that there are now 10 stock exchanges all pursuing the same strategy. All are scrambling to find ways to differentiate themselves in what has become a commodity business. Most observers don't believe the market can support 10 exchanges; they expect consolidation.

The chance for the National to set itself apart came last April, when Nasdaq announced changes to the way it worked with ECNs.

Nasdaq informed the ECNs publishing their quotes on its system that when it consolidated trading on its new "Singlebook," it would require them to accept automatic executions. It would end order delivery. Also, in the interim, Nasdaq would charge them for every order it delivered.

Nasdaq's moves were unfair, the ECNs charged, and would put them out of business. Nasdaq had traditionally "delivered" orders to the ECNs, giving them a millisecond or so to decide whether or not they wanted to execute.

That gave ECNs protection against the primary risk of an automatic execution: the double fill-one fill on Nasdaq and one on their own books from customers that accessed them directly. Nasdaq also traditionally charged the senders, not the recipients, of those orders for delivery.

New Opportunity

The ECNs complained loudly to the SEC, but to no avail. Nasdaq went ahead with its plans, and most ECNs moved their quoting business elsewhere.

"Once Nasdaq eliminated order delivery," Rizzello says, "the competitors of Nasdaq and the New York Stock Exchange needed a place to do their business. We saw that as an opportunity."