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April 16, 2007

ITS Passes Torch to Private Linkages

By Nina Mehta

The Intermarket Trading System is passing into history. The order-routing network that connects exchanges and market centers launched in 1978 and will expire at the end of June.

In the meantime, the ITS Plan, which governs the terms of intermarket access by self-regulatory organizations that trade listed stocks, became obsolete on March 5, when the trading phase of the Securities and Exchange Commission's Regulation NMS began. The demise of the ITS Plan ended the old trade-through rule, which was replaced by Reg NMS's quote protection rule.

The ITS Plan was administered by nine securities exchanges (the International Securities Exchange was not included) and the NASD. The NMS Linkage Plan, which has operated concurrently with the ITS Plan since last October, is run by the nine exchanges. ITS itself continues to be operated by the Securities Industry Automation Corp., now fully owned by the New York Stock Exchange.

Exchanges can use ITS, officially known as the NMS Linkage System, to send and receive messages until June 30. But it was expected to be rendered obsolete early this month when the NYSE-the last exchange using ITS for outbound routing-was due to switch to private linkages.

"It was always anticipated that ITS would go away," says Joseph Rizzello, chief executive of the National Stock Exchange. "We should retire it and give it a gold watch."

Private linkages will now connect all 10 national securities exchanges and the NASD's Alternative Display Facility participants. These linkages give market centers immediate access to better-priced bids and offers on other markets and allow them to avoid trade-throughs.

ITS critics say quotes in away markets often disappeared when "indications" were sent to them, and that market makers took too long to respond. The result was that ITS delayed broker-dealers from getting fills without providing the price improvement it was supposed to facilitate.

"Private linkages are faster and more efficient than a public linkage, and will result in more innovation," says Tom Richardson, president of the Boston Equities Exchange.

Mike Barth, senior vice president for exchanges and market centers at broker-dealer Order Execution Services, notes that "private linkages will ensure greater certainty of execution. Reg NMS's requirement of immediate execution will reduce one of the industry's biggest problems with ITS, which was no execution or slow execution."

Private linkages entail several changes for exchanges. In addition to physical connectivity to the other market centers, exchanges must have an outbound access broker to enable customers that are not members of away markets to execute on those markets. They also need an outbound router or technology provider that decides where to send orders.

Several exchanges, including NYSE Arca and Nasdaq, have broker-dealer subsidiaries for this purpose. The Philadelphia Stock Exchange and the ISE use broker-dealer subsidiaries of Order Execution Services that are deemed "order-routing facilities." The National and Boston are considering whether to shift this function from the clearing brokers they currently use to their own subsidiaries.