Once again, we offer market structure predictions for 2007 to bring in the New Year. A reckoning of last year’s predictions follows this year’s list.
1. NYSE and Nasdaq Continue to Converge. Already begun with NYSE’s ECN-ification via Hybrid, the convergence between our two major equities markets accelerates in 2007. In Q1, NYSE closes its Euronext deal; Nasdaq’s path to merge with LSE is rockier, but equally successful. (In fact, more successful longer-term, given deeper integration versus the NYSE-Euronext “Franken-exchange.”) By June, Nasdaq offers listings in one-, two-, and three-letter ticker symbols, blurring the lines between the two from the vantage of corporate clients. The NASD-NYSE regulatory merger happens. On the trading side, at year-end, Nasdaq is flat at 50 percent share. NYSE share loss continues. NYSE Group ends the year at 55 percent share. ARCA accounts for 35 percent and Hybrid 20 percent. At year-end, the floor is just a marketing device for media and issuers. The similarities between NYSE and Nasdaq outnumber the differences.
2. For-Profit Exchange Heartburn. In 2007, it’s not just garish valuations and vertical price charts that garner attention for our newly for-profit, publicly-traded exchanges. Having taken utility exchanges for granted since time immemorial, various constituents begin to push back. In the battle for order flow, brokers try to limit exchange-pricing power by moving liquidity; exchanges consider, but don’t yet launch, the nuclear option of direct institutional access. On listings, competition heats up. The benefits flow through to corporate clients. Market data fees are attacked by vendors, but the SEC resists a call to extend the current regulatory scheme to proprietary products.
3. NSX-BATS-DirectEdge Merge. In the race to create an exchange “third banana,” three of the most promising anti-duopolists merge: the National Stock Exchange (NSX), the BATS ECN, and Knight’s DirectEdge ECN. The result is a tech-savvy exchange with Crazy Eddie prices, run by brokerage owners interested in cost control, not exchange profits. The combo leaves other anti-duopoly projects-such as Boston’s BeX, CHX’s “New Market Model” and PHLX’s XLE-in the dust. And with 15 percent share of both the Nasdaq and listed tapes, its exchange-as-utility model raises questions about the inevitability of for-profit exchanges.
4. Dark Pools, White Heat. The broker-sponsored “dark pools” of liquidity exploded in 2006. And 2007 brings contention as these, along with “dark” exchange offerings, take aim at independent providers such as ITG, Liquidnet, Pipeline, and NYFIX Millennium. Ultimately, broker-sponsored pools are an automated version of a sales trader’s blotter, therefore lack scale, anonymity and prove tricky to link with blotters at competing firms. Exchanges, however, prove effective challengers to current dark pool providers, and make progress using scale and price as weapons.
5. NMS Enters, Tick Test Exits. After another short delay, Reg NMS is implemented in 2007. The SEC’s promised benefits, such as $1.5 billion of savings from increased limit orders, never materialize. And implementation costs exceed SEC estimates. The project serves as another marker between the William Donaldson-led SEC, which did not sufficiently consider the economic costs of regulatory adventures, and future SEC commissions, which (hopefully) do better. The NYSE’s support of the rule-effectively easing entry to a swelling tide of competitors-remains a mystery. By contrast, the SEC permanently removes short selling tick and bid tests in April for implementation in August. Rollback of a 70-year-old rule that is ineffective and harmful would warm Milton Friedman’s heart.
6. Penny Pilot for Options is Successful. At long last, penny quoting and trading comes to the options market in January. The pilot, which includes QQQQ and IWM, proves substantial and successful. The script reads like equities in 2001. Spreads tighten as black box traders compete with traditional market makers. With costs down, volume increases, as investors trade more often. ECN-like exchange models, such as ARCA’s OX and Nasdaq’s new launch, prove successful, taking a combined 30 percent share (ISE is flat; CBOE loses). Payment for order flow falls precipitously. More institutional investors embrace the options product. Portfolio margining acts as a tailwind to all these trends. While the pilot isn’t formally expanded or approved permanently in 2007, the trend is clear: Nickels and dimes aren’t coming back.
7. CBOE Merges with CME/CBOT. Faced with a quickly-changing landscape (pennies) and in a pickle over ownership (status of CBOT exercise rights), CBOE joins the merged CME and CBOT in late 2007. The triumvirate gives Chicago a powerful multi-product combination, and the integration of the organizations around CME’s technology and clearinghouse succeeds. It also sets the stage for CME’s entry into equities.
8. Shakeup in Equities Clearing. A favorite suggestion of the anti-CME/CBOT crowd is that it “spin off” clearing, so that futures trading would have a mutually-owned clearinghouse, along the lines of DTCC for equities. Instead, with interest rates back at reasonable levels and exchanges in constant search of earnings growth, an effort begins to make equities clearing a for-profit idea. With the industry-DTCC tussle over trade compression, we’re well on our way by the end of 2007.
2006 Scorecard. By our lights, we got it right on five, wrong on two, and the last was a push (See Traders Magazine, February 2006). On the plus side: Nasdaq’s share of listed trading (over 30 percent) easily bested NYSE’s share of Nasdaq trading (around 21 percent) at year-end; the SEC punted implementation of Reg NMS to 2007; BATS and DirectEdge dominated the regional exchanges in the scramble for liquidity; the industry adopted a plan to trade options in pennies; and CME did a few smart things, including new FX and credit event products, an agreement to run GLOBEX for Nymex, and a whopper of a merger with erstwhile rival CBOT.
On the minus side, NYSE did actually implement its Hybrid system and our top on algorithmic trading has yet to materialize (indeed, “algos” are still popular). We’ll take a push on unbundling: While few have followed Fidelity’s example of hard dollars for research, rising interest in commission-sharing agreements suggests commission dollars will be used to buy execution and research at competitive rates.
Jamie Selway is a founder and a managing director of White Cap Trading, New York.
