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November 13, 2007

Nasdaq to Launch a New Market

By Nina Mehta

The Nasdaq Stock Market plans to launch a second equities exchange in the first quarter of 2008. The license for that market, which Nasdaq will gain when its acquisition of the Boston Stock Exchange is completed, will be used by the exchange provider to attract "more new players and different strategies that we're not covering fully now," said Adam Nunes, vice president for transaction services at Nasdaq.

The new exchange, which hasn't yet been named, will run on Nasdaq's INET technology, which underpins Nasdaq's current market. According to an analyst briefing in early October, Nasdaq hopes a second market will boost its market share-and enable it to regain at least the 3 percentage points in share it lost when it went from three books to one in October 2006.

Nasdaq's main reason for launching a second equities market is to attract different types of orders through a different pricing structure. Nasdaq would not provide details, but suggested in its analyst briefing that the new pricing would not include volume-based tiering. Chris Concannon, executive vice president for transaction services at Nasdaq, told analysts that "alternative" pricing models could allow Nasdaq to "attract liquidity quite quickly and quite dramatically" to its second market.

Importantly, the second market will sit at the top of Nasdaq's routing table, Nunes told reporters at last month's Security Traders Association conference in Florida. That means marketable orders routed out of Nasdaq will first check the second market when it is tied at the national best bid or offer with other markets. Nunes said this is critical for the new exchange, because Nasdaq is the "largest router on Wall Street."

Concannon explained that "the second quote that we run through this license will sit inside our data center... Because of the connections that we currently maintain in our data center, that distribution channel is phenomenal." He added that having a second protected quote makes the new market "a very easy sell for firms that wish to populate the quote."

It's possible Nasdaq's second market will not route out to other markets, Nunes said at the STA meeting. Currently, the Chicago Stock Exchange is the only other exchange that doesn't route orders to other markets. Concannon added at STA that the new market could have different order types from what currently exist on Nasdaq.

In addition to increasing Nasdaq's market share and fill rates for customers, a second market may enable the company to boost its market data revenues. Market data revenues are now allocated based on quote and trade data, as opposed to just trade reports before Reg NMS was implemented.

Currently, "our quote share is less than our market share," Nunes said. Owning another market that attracts more posted liquidity could therefore increase Nasdaq's quote-based revenues.

Nunes noted two additional reasons for launching a second market. Both relate to the fact that Boston is part of Tape B for purposes of market data. Market data revenues are allocated according to three "tapes": Tape A for New York Stock Exchange-listed securities, Tape B for securities listed on the American Stock Exchange and the regionals, and Tape C for Nasdaq-listed names.

The Boston license consequently gives Nasdaq access to Tape B revenues. Nunes said Boston's Tape B revenues are currently "under four figures," but that they could increase.

In addition, the Boston license enables Nasdaq to offer new issuers one-, two- and three-character ticker symbols. Currently, Nasdaq is limited to four- or five-character symbols for Nasdaq-listed firms, unless an issuer with a three-character ticker switches its listing to Nasdaq. Concannon said Nasdaq would consider reverting to the QQQ symbol for the Qubes, one of the most popular exchange-traded funds in the U.S. In 2004, when the ETF's listing was switched to Nasdaq from Amex, which had brought the product to market in 1999, Nasdaq changed its symbol to QQQQ.

Nasdaq will acquire the BSE for $61 million-$38 million in cash and $23 million in assumed debt. In addition to the SRO and its license for trading equities and options, Nasdaq received the BSE's clearing corporation and the Boston Options Exchange regulatory unit. BOX, which Nasdaq did not buy, will continue to use the BSE's options license.