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February 13, 2008

NYSE to Cut Specialist Capital

By Peter Chapman

The New York Stock Exchange has asked the Securities and Exchange Commission for permission to reduce specialists' capital requirements.

Under a proposal submitted to the regulator late last year, the NYSE would reduce the amount of net liquid assets (NLA) specialists are required to maintain by 75 percent. Current levels are unnecessarily high, the NYSE says, while the proposed amount is adequate to maintain the market's integrity. 

"Specialist positions and the likelihood of losses have been reduced dramatically, due to changes in the structure of the market," the Big Board wrote in a filing. "The increased efficiency with which others can access the exchange's market has increased liquidity and decreased the market's reliance on the specialist to provide the contra side in our continuous auction."

Increased electronic trading under the NYSE's Hybrid initiative has caused specialist participation rates to plummet to 3.9 percent in December from 8.5 percent in November 2005, according to the exchange. The drop has produced smaller positions that need less capital to support.

LaBranche & Co., the largest of the six specialists, for instance, traded 2.2 billion shares for its own account in last year's third quarter, down from 4 billion shares in the third quarter of 2006. The specialist is in favor of the NLA reduction and figures its net liquid assets requirement of $270 million at the end of September 2007 would have been $74 million under the proposed NYSE plan.

"This would be a very positive development for our cash equity specialist business," Michael LaBranche, the firm's chief executive, told analysts last October. LaBranche, which lost $370 million in the first nine months of last year, has indicated it could reduce its debt load with any savings if the NYSE's proposal is approved.

(Lehman Brothers, which just became an NYSE specialist, has said that the prospect of an NLA reduction played a key part in its decision to become an NYSE specialist. See article on page 8.)

Net liquid assets refer to cash and cash equivalents accessible by a specialist within 24 hours. The funds are meant to be used by the specialist in the performance of his affirmative obligation to make a fair and orderly market. They also serve to assure other traders that the specialist has sufficient liquidity to support his stocks.

Under current NYSE rules, the specialist is required to maintain $1 million in NLA for every one-10th of 1 percent (0.1 percent) of the dollar value of his securities plus a "market risk add-on." The figure does not include exchange-traded funds. The specialist must keep $500,000 for every ETF he trades.

Under the proposed rules, the specialist will have to maintain $250,000 in NLA for every one-10th of 1 percent (0.1 percent) of the dollar value of his securities plus a market risk add-on. The requirement for ETFs will not change.

The Big Board expects to reduce the exchange's overall NLA position from $1 billion to $250 million with the plan. If approved, it would be the second reduction to specialists' capital requirements since 2006.

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