Reviewed by Gregory Bresiger
Edited by Robert A. Schwartz, John Aidan Byrne and Antoinette Colaninno
(Kluwer Academic Publishers, Norwell, Massachusetts, 157 pages).
Should it be "Back to the Future" for the markets? Are call auction markets – once used widely in the United States and now no longer as popular – the way to solve some of the persistent market structure problems, which include fragmentation and inadequate liquidity?
These were some of the questions considered at a conference some three years ago. This book recounts some of the debates about market structure. So the book can be profitably read by almost anyone in the trading industry.
The academic who led much of the discussions, Robert Schwartz, says he became intrigued with the idea of the call auction some 30 years ago. "Back then," Schwartz writes, "just about nobody on this side of the Atlantic knew what the term meant. However, at the time, non-electronic call market trading was used in several European markets, including Paris, Brussels, Frankfurt and, further to the east, Tel Aviv."
(Schwartz collaborated on this book with the man who edits this publication, and Antoinette Colaninno of Baruch College.)
Call auctions bunch orders together. The example used in the book is a store with several different lines. Some customers frequently jump lines in the hope of obtaining faster services. Employing the call auction system would mean one big line in which everyone had the same chance to be waited on.
Under a call auction market, orders are completed at specific points in time and through multilateral trades. By contrast, the more commonly used continuous trading system has executions whenever a buy or sell order meet in price.
How would one integrate continuous and call auction trading? Gerald Putnam, of Archipelago, and Junius Peake, an academic at the University of Northern Colorado, had an exchange on the dynamics of two different systems that are linked. What happens, Putnam asked, if the call auction's single line breaks down? What happens when immediate executions don't work, another conference participant wondered? These kind of problems, Putnam added, regularly happened on Nasdaq and on SelectNet.
"I've seen the NYSE shut down for days. The world does not come to an end," Peake said. "Well," Putnam noted, "it does come to an end for continuous trading. All I am saying is that competing linkages and competing market places will allow for multiple linkages."
The idea of call auctions is so old, some might say it is actually new. The Big Board had used a call auction system until the late 1860s when it turned to a continuous system. So, then, why return to the past?
Schwartz says the call auction system would make sense today because it is computerized. "A traditional and a computerized call are two very different systems. Computer technology is essential for unleashing the power of a modern call. This call, in turn, makes excellent use of electronic technology," Schwartz said.
Distinct Advantages
There's another reason to go to a computerized call system, its supporters claim. It's a very simple reason; one that the Scottish economist Adam Smith wrote about over two centuries ago: self-interest. Schwartz and others contend that the market that adopts such a system will have distinct advantages. According to Schwartz, "a call auction, be it the NYSE, Nasdaq, or an ECN or ATS, will, I believe, appreciably increase its ability to attract order flow."
Well, maybe.
But somehow I can't imagine the staid, traditional Big Board going to such an innovation before most of its competitors. And Schwartz and others concede several roadblocks to their seemingly better mousetrap. For one, there's the sellside. Participants on the sellside fear they could be the victim of the march of progress.
Indeed, call auctions, some believe, would "dis-intermediate the market." That could hit them where they live – in their collective wallets. Secondly, opposition to the idea comes from those who don't understand it, from those whose natural impulse is to resist change. In other words, from most of us who are daily assaulted by a dizzying pace of change.
There is a natural reluctance to tamper with a market structure that works for some and is therefore resistant to major change. Kenneth Pasternak, at the time of the conference the CEO of Knight Trading Group, and today an executive of Chestnut Capital, cautioned that any market structure that can't satisfy the individual investor is going to fail.
"Our vision of a perfect market at Knight," Pasternak said, "is probably in sharp contrast to the proponents of a call auction. We advocate a continuous, 24-hour market in which individual investors can execute their orders immediately, at a low cost and at the best price reasonably available at the time of execution."
Pasternak suggested that the best market structure from an academic point of view migh not be the same as the one individuals will accept.
This, I believe, is a polite, or possibly fancy, way of saying that intellectuals and academics live in different neighborhoods. And the neighborhood of the academic is not the same neighborhood as a market professional. The latter is risking huge amounts of capital every day and is often crushed by brutal markets. An example of this is Pasternak's former employer, Knight Trading Group, which is now facing a tough struggle to survive as countless market makers fall by the wayside.
But another academic said he had mixed opinions about call auctions; that some think they provide market participants with perfect information, or optimality.
"Proponents of call auctions cite their optimality," according to Ian Domowitz, with ITG and, at the time of the conference, a professor of finance at Penn State University.
"That theoretical position is not valid in my opinion. On the other hand, there are probably some interesting ways in which call auctions could be used to respond to various market structure issues," Domowitz said.
European Markets
Nevertheless, call auctions already have been tried by several markets. The experiments have all failed so far, Schwartz concluded in the remarks that close this book.
Still, it's clear that–given their success in European markets – that we have not heard the last of the debate over this controversial trading method. The potential of greater order flow will egg on someone.
One rises from these discussions about call auctions convinced that they will continue to be part of the larger ongoing debate in the United States over finding a new, more effective market structure. The debates over call auction will likely continue just as long as human beings are interested in finding the next best mousetrap.
