The International Securities Exchange, one of the country's top two options marketplaces and the first all-electronic options mart, is crossing over into the equities trading business. This month the ISE Stock Exchange will launch its first product, a blind, continuous-crossing mechanism called MidPoint Match. The system matches orders anonymously
at the midpoint between the national best bid and offer. In December, ISE expects to commence trading on its new platform in open-book fashion.
The ISE owns 51 percent of the new exchange. Its 10 strategic partners are Bear Stearns, Citadel Derivatives Group, Deutsche Bank, a subsidiary of E*Trade Financial Corp., Interactive Brokers Group, JPMorgan, Knight Capital Group, Nomura Securities International, Sun Trading and Van der Moolen.
The target market for the new crossing platform is program trading and algorithmic orders, two areas of trading that are expected to continue to grow. Running the brand-new equities market is Andrew Brenner who joined the ISE in May. Brenner most recently worked for the Capital Markets Group of Fidelity Investments. During his two-and-a-half years in the firm's institutional brokerage business, he was responsible for program trading as well as algorithmic trading and analytics.
Before Fidelity, Brenner was at Credit Suisse First Boston, where he was responsible for listed equity derivatives and portfolio trading for the firm's customer-based business in Europe, Asia and the U.S. Prior to CSFB, he was at Morgan Stanley.
Senior Editor Nina Mehta spoke with Brenner to learn more about the exchange's plans and strategies for its new foray into equities.
TM: The ISE is launching a stock market when there are already more than dozen execution venues for equities. How do you expect to attract business?
Andrew Brenner: We think the MidPoint Match is a unique product. It's a fully automated, continuous, anonymous, algorithmic-friendly product. In December we expect to roll out our fully displayed market, which will be Reg NMS-compliant. The MidPoint Match embedded in a fully displayed market differentiates us from others out there.
TM: Why is the MidPoint Match being launched first, ahead of the displayed market?
AB: We're viewing ourselves as a MidPoint Match exchange. That's the highlight of the exchange and we want people to understand that.
TM: Crossing networks such as Liquidnet, Pipeline and others have been successful in recent years, and many broker-dealers now have alternative trading systems to cross customer orders. Did that fuel the launch of MidPoint Match?
AB: We've certainly seen the success of broker-sponsored crossing venues, and we're aware that many brokerage firms are internalizing their flow. We felt there was still a need for an exchange platform that's totally neutral and where all flow could potentially get equal standing.
TM: What are other benefits of a crossing system within an exchange?
AB: A client can sit on the bid [on the displayed side] and hide up to the midpoint, so they get the benefits of both the displayed market and the hidden market.
TM: Can you give me an example of what you mean?
AB: Say a stock is $10 bid, offered at $11. Someone may want to sit on the bid at 10, but is willing to pay up to 10.50. The person may not want to move the bid side up to 10.50, but he may want to be represented in the MidPoint Match up to 10.50.
TM: What types of customers are likely to find the MidPoint Match attractive?
AB: We hope to attract any and all investors. We'll take small orders, large orders, and algorithmic orders. Some crossing venues take only large-size orders, or only buyside orders, or they're not continuous. We spent a lot of time talking to ISE members and felt there was a need and desire to have a continuous crossing vehicle that took orders of all sizes.
TM: How is the MidPoint Match geared toward algorithmic trading?
AB: Algorithms are sliced over a period of time and tend to be smaller-size orders. You need a continuous venue to slice an algorithmic order, and you need a venue that can accept smaller orders.
TM: You will need customers to leave resting orders in the MidPoint Match?
AB: Arguably an algorithmic order would be a resting order for a period of time.
TM: How? Won't an algorithm just be carving off pieces to send to execution venues?
AB: Most algorithms don't immediately pay the offer or hit the bid. They try to buy on the bid or buy on the mid, or sell on the offer or sell on the mid. Everyone has a slightly different algorithm and style, but crossing the market-if you're a buyer, then paying the offer, or if you're a seller, hitting the bid-is the trade of last resort for any algorithm.
We anticipate that agency brokerage firms will leave resting orders with us. We also expect algorithmic desks, statistical arbitrage desks, and options traders to leave resting orders with us. A stat arb desk can source liquidity and receive price improvement in the process. I can also see a scenario where an agency brokerage desk has 300,000 shares to buy over the course of a day. They may leave 50,000 shares sitting in MidPoint Match. It's anonymous and there's no footprint. If it gets filled, they can add more while they're working a portion of the order in the displayed marketplace.
TM: Do the ISE's 10 strategic partners have warrants, or volume or fee thresholds, that will allow them to increase their ownership share of the ISE Stock Exchange?
AB: No. There are no warrants, and no fee or volume commitments. We expect our strategic partners to work with us to help the ISE Stock Exchange earn a leading position in the marketplace.
TM: Do you expect brokers that have their own dark liquidity pools to access MidPoint Match to try to match orders?
AB: Absolutely.
TM: How long did the ISE work on the MidPoint Match?
AB: It's been close to two years in development.
TM: Why did it take so long?
AB: We were creating a stock exchange from scratch, so we had to develop the technology, define the rules and figure out what the needs of the industry were.
TM: Some exchanges are talking about rolling out intraday crosses. At the same time, there's a concern that exchanges might be competing with market makers and their member firms. Does the MidPoint Match compete with market makers and broker-dealers?
AB: Since we're an exchange, no buyside customer can access us directly-they must go through a member of the ISE. As far as market makers go, we're an order-driven market, not a quote-driven market. So we won't have formal market makers.
TM: How much will you charge for transactions?
AB: We're waiting for final approval from the Securities and Exchange Commission, so we can't comment on that. Broadly speaking, the displayed market will have maker/taker fees and MidPoint Match will have fees for both sides. Our fees will be competitive.
TM: What's the minimum order for the matching system?
AB: We take round lots, so 100 shares or more.
TM: Can users put a minimum block size in MidPoint Match?
AB: That would have to be done through an all-or-none [AON] order type. Someone could submit an AON order for 25,000 shares, for example. We also allow fill-or-kill and immediate-or-cancel orders.
TM: What do you expect the average order size executed in MidPoint Match to be?
AB: We're open to any and all order sizes. If our order flow is made up of smaller orders, that's fine. If it's block-size orders, that's spectacular as well.
TM: Is everything in MidPoint Match price-time priority except solicitations of interest [SOIs] and AONs?
AB: Yes. Let me explain how a solicitation of interest works, since it's different from an indication of interest. An SOI is an advertisement that someone wants to execute an order that's a minimum of 2,000 shares. A message is sent out with the symbol but no side or size. The person who submitted the SOI moves to the top of the book for a minimum of five seconds and a maximum of 10 seconds.
That person can't cancel the SOI for five seconds-so it's a firm order, unlike an indication of interest, which is not a firm order. But that person has priority on the book for a total of 10 seconds, unless the order is canceled after five seconds.
TM: For buy-writes the ISE currently executes the stock portion through NYFIX Millennium. Will that change when you have the stock exchange?
AB: We've been very pleased with the arrangement with NYFIX. We're always evaluating what arrangements will achieve the most efficient execution for members, and we'll continue to do that.
TM: What order flow could come your way off the ISE options exchange?
AB: An options facilitation desk at a brokerage may take down a position for a customer and need to put on a hedge as quietly as possible, without leaving a footprint. MidPoint Match lets them do that. Options desks with complex positions could also use MidPoint Match to adjust their delta hedges.
TM: How will you route out to other exchanges when you have a displayed market?
AB: We'll be fully functional in terms of our route-out capabilities. We anticipate using a vendor product.
TM: Is there a cost to be an ISE Stock Exchange member?
AB: Brokerage firms must be members of the ISE to trade options or stocks. If they're trading options, there is a minimal additional charge to become a user of the stock market, and vice versa.
TM: How will your customers access MidPoint Match?
AB: For ISE members, becoming an active user of the ISE Stock Exchange is basically signing two documents and getting another session of their FIX connection to us. It's minimal development work. They will be able to use the same front end they're using to get to us on the options side.
TM: What about PrecISE, your new front-end platform? Do most traders connect to ISE using their own front ends or through PrecISE?
AB: It's a blend of people using their own front end or CLICK/PrecISE. CLICK users are currently migrating over to PrecISE. We're now doing the analysis and development work on access to the stock exchange through the PrecISE platform.
TM: The Chicago Board Options Exchange is entering the equities space as well. Why are options exchanges climbing over the fence?
AB: I can't comment on the CBOE's rationale. We saw an opportunity in the equities space. As a company we have rigorous internal guidelines for evaluating new initiatives. If we can't add value, if we don't have the expertise, or if we can't make money, we'll pass. With ISE Stock Exchange we met the first criterion by speaking with members and identifying what was missing in the equities space. MidPoint Match is the product of those conversations. We also have the necessary expertise on the technology side to create a competitive exchange platform in-house. We're confident it will be successful.
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