Commentary

Lesli Fairchild
Traders Magazine Online News

What Next for Traders Saying Goodbye to AOL Instant Messenger?

In this exclusive to Traders Magazine, Lesli Fairchild discusses how the DEC 15 shutdown of AOL Messenger will affect traders and what alternatives are out there.

Traders Poll

Is information leakage a major concern of yours when you trade?



Free Site Registration

April 3, 2008

ECNs Encroaching on Exchange Turf

By Nina Mehta

Also in this article

  • ECNs Encroaching on Exchange Turf

All eyes are on BATS Trading and Direct Edge. Will the Securities and Exchange Commission grant the two biggest ECNs the much-coveted exchange status they both want? If so, will the exchanges leverage their newfound powers to grab more share from NYSE Euronext and Nasdaq OMX? And what about the value of exchange licenses? Will approval herald a flowering of new exchanges, devaluing the status of the smaller players already in the club?

After months of planning, BATS filed for a license to be a self-regulatory organization in November. The SEC published the application for public comment in February. Direct Edge last month told Traders Magazine it would file for two exchange medallions by the end of May. The double-SRO approach is designed to enable Direct Edge to maintain its current competitive model of two pricing structures for trading systems run on the same technology platform.

In February, BATS and Direct Edge represented a combined matched market share in NMS securities of close to 12 percent, with BATS accounting for two-thirds of that. The aggressive pricing of BATS in particular has pressured rivals Nasdaq and NYSE Arca to rejigger their pricing. More generally, ECNs over the last decade proved that a certain segment of liquidity is transportable, and could be shifted among market centers based on pricing or other incentives.

Now, BATS and Direct Edge want exchange status to compete more aggressively with the behemoths-NYSE Euronext and Nasdaq OMX Group-each of which will soon have three SRO licenses under its corporate roof.

"As an exchange, you control your own destiny," said William O'Brien, chief executive of Direct Edge. "You're not tied to a third party in terms of how your quotes are reflected in the NMS. You can deal with operational changes unilaterally, rather than worrying about the downstream consequence on your quoting and trade-reporting vendor."

Both ECNs expect the consolidating exchange landscape to facilitate their transition to SROs. According to O'Brien, the progress BATS's application has made so far is an "encouraging sign" that exchanges could get approved in the not-too-distant future. The SEC has been notoriously cautious about approving exchange applications.

Lanny Schwartz, a partner at law firm Davis Polk & Wardwell, said operating as ECNs won't give BATS or Direct Edge a leg up in meeting the SEC's technical approval standards for exchanges. That process, he observed, can be painstakingly gradual as the SEC ensures that regulatory, compliance and other systems are adequate.

However, the two markets' current business as ECNs could ease the process. According to Schwartz, the commission "will have examined them in their current incarnation. [The SEC] knows their systems and understands their technology, compared with someone coming in new. That's got to be helpful." Schwartz heads his law firm's broker-dealer and market regulation practice, and was previously general counsel of the Philadelphia Stock Exchange.