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December 8, 2008

2008 Review: NYSE Fights Back with Designated Market Makers

Turbulent Times

By Peter Chapman

Will 2008 mark a turning point for the New York Stock Exchange?

The Big Board, after enduring two years of declining market share as traders shifted their business elsewhere, took steps this year to win it back by partly reshaping itself along the lines of its chief competitor.

Like Nasdaq, the New York will now operate a competitive dealer marketplace. With Securities and Exchange Commission approval, it jettisoned its decades-old monopoly-specialist structure and created two classes of market makers charged with supporting its stocks.

Specialists are now called designated market makers (DMMs). They have been freed from nearly all restrictions on their trading and given new privileges. They can now compete against other exchange members for trades, rather than facilitate trades for them, as had been their charge. Where once they had to step back from a trade if a floor broker or DOT order was at the same price, now they have equal standing.

Not everything is going their way. With the change to a multi-dealer structure, DMMs will lose their exclusive rights to make markets in their assigned securities. The exchange has created a new class of market maker called the supplemental liquidity provider (SLP) who will be able to trade the same stocks as the specialist.

The exchange created the SLPs in the likeness of DMMs, but with significant differences. SLPs can only trade from offices outside the exchange. DMMs, on the other hand, are located on the floor of the exchange. DMMs must quote two-sided markets at least 5 percent of the day. SLPs only need to quote one side of the market at least 5 percent of the day.

SLPs will not be as richly rewarded as DMMs for quoting. Like its competitors, the New York will now start paying competitive rebates to those market makers who supply liquidity to the NYSE book. DMMs will get 30 cents per 100 shares if a trade happens. SLPs will get 15 cents. The exchange has not extended this rebate policy to floor brokers or other upstairs traders, although it does pay floor brokers 4 cents per 100 shares.

These changes come as the New York's share of trading in its stocks has slumped to a low of about 24 percent. That's about the size of Nasdaq's market share in Big Board securities. For a few days this summer, Nasdaq actually traded more NYSE shares than the home market.

To beat back Nasdaq's advance, the New York has decided it needs to look more like its archrival, which mixes in competing dealers with limit-order traders. In contrast to the Nasdaq model, however, New York's DMMs and SLPs are essentially prop shops. They trade only for their own accounts-not for clients. The six designated market makers now operating on the NYSE floor will be permitted to coordinate their trading activities with their firms' proprietary desks.

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