Active specialists making tighter markets and improved technology are considered the linchpins to a bright future for the American Stock Exchange, now known as NYSE Alternext. NYSE Euronext completed its acquisition of Amex in October.
Today is just the third day the old Amex market has operated as NYSE Alternext in the Garage of the New York Stock Exchange. But hope is emerging that the new ownership and market model will enable the once-powerful Curb market to regain some of the ground lost in recent years.
For Bob Nunn, chief operating officer at Cohen Specialists, one of four specialist firms that transitioned to Alternext, technology is the key to success. “Technology is the backbone of it all,” he said. “It will enable us to make better markets and to participate a lot more easily than we did at Amex.” That could benefit the listings side of the business as well, he said.
Alternext is starting with approximately 15 percent of the market share in its own listed stocks, although NYSE Euronext expects that could double by the end of 2009. The innovative exchange-traded funds business, which Amex created in 1993, was recently moved over to NYSE Arca’s faster electronic platform, which operates more like an ECN.
In Nunn’s view, technology problems at Amex caused its drop-off in market share over the last several years, despite ongoing efforts to catch up with the rest of the marketplace. When the Amex membership bought the exchange back from NASD in 2004, he said, the exchange wasn’t prepared to meet the requirements of Regulation NMS. “The new administration was under the gun to build a system to comply with NMS,” he said. “Not a lot of effort was spent on integrating the specialists into the design of the front end and matching engine, so there was no way for specialists to interact with order flow in the way that we had been doing.”
Now, Nunn and other specialist firms are counting on new ownership to help the exchange reverse that trend and improve the quality of its market. The other three specialist firms at the exchange are Kellogg Capital Group, J. Streicher & Co., and Brendan E. Cryan & Co.
The NYSE Euronext mothership would also like to strengthen its latest market. “We will look to do creative things to try to build up Alternext market share and activity over the next few months,” said Joe Mecane, executive vice president and chief administrative officer for U.S. markets at NYSE Euronext. The exchange company has simplified Alternext’s pricing for member firms and switched to a maker-taker fee schedule to be more competitive. The company also moved Alternext over to the rule set that constitutes the NYSE’s new market model.
Nunn expects Alternext’s market share to increase under NYSE Euronext’s banner. In his view, the new market model will boost market share by making it easier for specialists to interact with flow. “Since the new market model rolled out [at the NYSE], there has been an increase in specialist participation in large-cap stocks and in market share, so they’re already seeing benefits there,” he said.
Patrick Fay, director of equity trading at broker-dealer D.A. Davidson & Co., agreed that being part of NYSE Euronext could increase volume in Alternext stocks. “We have more connections to the NYSE,” he said. Before, “we didn’t do enough business on Amex to warrant the cost of having a direct connection to that exchange.” In addition, he said, Amex “was perceived as less customer-friendly, and many investors who previously shied away from Amex stocks may now return. There will be greater access and visibility for most of those listed equities, so it’s reasonable to assume that volumes should go up.”
Andy Schwarz, senior partner at AGS Specialists, hopes the move to the NYSE will improve prospects for Alternext. “I am cautiously optimistic the New York will understand the small-cap and micro-cap business,” he said. “If so, it will be a great opportunity for specialists and for the country. General Electric can tap the credit market anytime, even if it must pay up for it at times, but access to capital doesn’t exist for a $100 million firm.” He added that Amex’s goal had always been to help those companies by injecting specialist capital into the market to provide liquidity, which ultimately added value and enabled the companies to tap the secondary market to raise money.
AGS, currently the largest options market maker on Amex, is eager to come over to the NYSE once the new options pits are ready in the Blue Room and Extended Blue Room. However, the firm decided not to move its equities business over to Alternext because the cost was prohibitive. “Between compliance and technology, for us to start our own cash equities operation on the NYSE just wasn’t cost-effective,” Schwarz said.
Still, the market remains important to Schwarz. “This is a marketplace that’s totally ignored in the capital market structure in the U.S.,” he said. “The London Stock Exchange recognized it when they built AIM, and they grew that market very quickly. It’s a special market and different from trading GE or Intel.” For these small- and micro-cap names, the presence of specialists who commit capital is vital for providing liquidity and taking positions, he noted. It also distinguishes trading on Alternext from trading on Nasdaq and Pink OTC Markets (formerly called the Pink Sheets).
NYSE Euronext has now applied the new market model built for the Big Board to the Alternext market. Designated market makers, formerly called specialists, have seen their obligations and the rules under which they operate change to accommodate faster electronic trading. For less-liquid names, the NYSE also gives DMMs monetary incentives to make tighter markets. They get 35 cents per 100 shares, plus the quote share of the market data revenues the exchange receives from the securities information processors, compared to a 30-cent credit for other securities. Alternext DMMs will get 35 cents plus the quote revenue for liquidity provided in Alternext names.
However, there’s no certainty that will suffice for extremely illiquid stocks. Whether a market model designed for the New York can be applied productively to the Alternext’s small-cap market remains an unanswered question. “On a 10-to-1 scale of importance, that’s 17,” Schwarz said. “But anyone who tries to answer that right now is shooting from the hip.”
Electronic markets work well in liquid stocks. But for thin, illiquid, micro-cap stocks, “it’s all about building Alternext to incentivize market makers to make tighter markets,” he said. “The rebate isn’t a game many want to get into for a stock that trades 2,200 or 6,500 shares per day. Whatever the credit is is peanuts and, by itself, not worth the risk for these stocks.”
NYSE Euronext’s Mecane noted that Alternext is a work in progress. The parent company, he said, is committed to supporting the market and will adjust the Alternext model and rules as necessary, based on trading experience in the weeks and months ahead.
Cohen’s Nunn is supportive of the exchange operator’s efforts. “The New York has been very receptive to our ideas about what the market model should evolve into,” he said. “And we are encouraged by early signs in terms of our ability to interact with [flow in] less-liquid stocks. Just the ability to have our own front-end and our own algorithms goes a long way to enabling us to make better markets in thinner securities.” His firm has algos to make markets on the Alternext platform now, but is building new proprietary algos.
Over the past 18 months, Cohen acquired four specialist operations in equities and ETFs. It first acquired LaBranche’s Amex book, then Bear Hunter’s. Then it bought AIM Securities, a specialist in equities and ETFs, prior to the latter names migrating to Arca (Cohen later became a lead market maker on Arca). And finally, it acquired the equities pad of AGS Securities. The firm now has about 15 people and is a DMM in about 500 stocks, warrants and preferreds. A year and a half ago, Cohen had seven or eight employees and was a specialist in 70 stocks.
However, none of this means moving to the NYSE’s Garage wasn’t an enormous change. At lunch time on Monday, Nunn said his firm had been down on the floor for three hours and that he’d been holding his breath for the first two. “It took a lot of work to get to this point,” he said. “The staff at the New York got us what we needed. From Duncan [Niederauer, NYSE Euronext’s chief executive,] on down, they were fully committed to putting resources behind the exchange.”
At the same time, Nunn admits that on Monday there was a “little sense of nervousness on the floor,” even as NYSE floor brokers and others came by to wish the Alternext specialists well. But then the optimism returns: “Maybe a month from now, they’ll forget how they did it on Amex.”
