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April 15, 2009

Specialists Trading Levels Climb

By Peter Chapman

The New York Stock Exchange's market share in its listed securities is growing for the first time in years, and exchange executives expect it to go even higher.

A reworking of the role of the specialist and the addition of a new type of market maker have served to boost the NYSE's market share. NYSE Classic, as NYSE Euronext executives call the Big Board, has grown its market share in recent months to about 26 percent.

That's up from 23 percent last summer, a period when Nasdaq was processing as much as or more volume than the Big Board. The upward trend is a turnabout from years of decline.

"There's significant room for growth," NYSE Euronext CEO Duncan Niederauer told analysts last week. "As you know, one of our biggest challenges in 2008 was to turn around NYSE Classic's market share and correct several flaws in the old hybrid model."

Niederauer believes NYSE Group, which includes both NYSE Arca and NYSE Classic, can increase its combined market share in the trading of NYSE-listed securities from a current 43 percent to 50 percent. He notes that is a "stretch goal," however.

The hybrid model, which went into effect in 2006, sidelined the specialist, which contributed to a steady drop in trading on the floor of the New York. The new model the NYSE instituted late last year reduced the obligations of the specialist, now called a designated market maker, and gave him new financial incentives to quote.

As a result, the specialist's participation rate, or the percentage of trades in which he participates, has jumped. DMM participation has risen from 3.6 percent in September to 7 percent in December to 8.3 percent in January.

The new model also added a new class of market maker called the supplemental liquidity provider, who also got financial incentives to quote. The exchange has signed up three firms to act as SLPs and is in the process of signing up a fourth. SLP participation stands at 6 percent.

The gain in volume that came with the new structure has not been without cost. The NYSE is paying DMMs a relatively high rebate of 30 to 35 cents per 100 shares for supplying liquidity.

In last year's fourth quarter, the exchange experienced a "significant increase" in liquidity payments, according to Niederauer. The rise continued into January. The exchange hopes to remedy this situation with new pricing that goes into effect next month.

Niederauer's projections notwithstanding, the NYSE's competitors aren't rolling over. A recent Celent report shows Nasdaq, BATS Trading and Direct Edge all gaining share in the trading of NYSE-listed securities.

Direct Edge, for example, according to Celent, saw a climb in its market share to 11 percent in the third quarter of last year, versus 3 percent in the same period in 2007.

The ECN sees opportunities to gain market share because of the pricing moves the NYSE recently announced, said Bill O'Brien, Direct Edge's chief executive. Direct Edge also hopes to compete with other fast-rising market venues by continuing to convert flow that it touches into matched market share growth over time.

"There's going to be vibrant, perhaps violent, competition between the order books and the floor, as well as among each other," O'Brien said. "As we've been winning business lately, we've been taking it from multiple sources, and I would expect that to continue."

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