(Traders Magazine, August 2005) — The New York Stock Exchange buys the Archipelago Exchange. Nasdaq buys Inet. The Securities and Exchange Commission votes in a new trade-through rule. What does it all mean? A roundtable convened by network provider BT Radianz at the Securities Industry Association's annual technology conference attempted to figure it all out. Brennan Carley, BT Radianz' chief technology officer, moderated a panel of five industry executives.
Participants included Joe Sommer, co-head of electronic trading at UBS, a brokerage; Eric Goldberg, the chief executive of Portware, a vendor of front-end trading systems;
George Hessler, of Lava Trading, a vendor of front-end and order management systems; Marty Kaye, chief executive officer of the Track ECN; and Dan Kramer, an executive with Thomson Financial. Below are excerpts.
Topic: Given the mergers underway at the industry's two largest marketplaces, the participants discussed whether there was still room for smaller players such as regional exchanges. The subject of ECNs merging with regional exchanges was broached.
Marty Kaye, Track ECN
At Track ECN, we are looking to partner with other people. We've been speaking to exchanges as well. I expect that all of the exchanges would like to go all electronic and would like to be able to compete as well as they can against the duopoly. I think they will be able to do that. I think most of the people we speak to our clients would like to see many viable entities to ensure there is fair pricing.
We just recently saw the Philadelphia Exchange take on two new partners – Citadel and Merrill. I think there's just going to be more of that. As I said, we are looking at different partners and talking about ways to create a viable entity.
I think all the regional exchanges are looking to do the same. I think you're going to see that either the regionals are going to develop their own ECN type of connectivity or they're going to partner up with an ECN. They may add some liquidity providers as partners who can help make them a more viable entity. In any event, I'd be surprised not to see numerous places to trade besides the two big guys that have been created recently.
I think it's highly unlikely that Reg NMS will happen within the time frame they've set. Some of the bigger houses will ask for additional time. There is certainly no way to put this in without having everybody on board. There are just too many regulations that would result in massive fines and other sort of penalties for not executing in accordance with NMS. So it's clear that they're going to make sure everybody's ready to go.
Dan Kramer, Thomson
I would agree with Marty. I think we have a unique combination of ECNs. They will require scale in order to thrive in the new world post NMS. And the regional exchanges will require technology in order to thrive. So, I think with both of those groups seeking partners or seeking new capabilities, further partnerships are inevitable.
Eric Goldberg, Portware
I think we're going right back to where we were six years ago [when we had several] ECNs. You've already seen Knight buy Attain. I know of a few groups that are forming and trying to do this.
George Hessler, Lava
I think without question we're going to have some new entrants. And we're going to see some strength in some regional exchanges. Reg NMS is a very competitive regulation. It's really designed to protect each of the venues. So if you want to make a venue yours, you can make a protected venue. Just put up your best bid and offer, and they can't trade through you like they can now.
Joe Sommer, UBS
As for the new Nasdaq and the new New York Stock Exchange it will be up to them to lose the order flow. If they price aggressively and fairly…If they deliver automated executions as dictated by Reg NMS, people will trade there. But if they don't, it will be very easy for people to innovate and get in the middle. And you're going to be forced to trade there from a regulatory perspective. So, as George indicated, it is a competitive regulation. But certainly Nasadq and the New York Stock Exchange, as projected, are going to have the lion's share of the order flow. But there is certainly room for competitors.
Topic: The future of electronic trading under Reg NMS. Compliance with the new trade-through rule is a focus. Whether the burden of proof rests with broker-dealers or market centers.
Joe Sommer, UBS
In general, Reg NMS makes equity trading more automated. Compliance, or demonstrating compliance, is going to become more complicated. With execution becoming automated, electronic trading will increase. Algorithms that now must deal with the uncertainty of a fill in the listed marketplace can be refined to anticipate completion at quoted prices. That will probably bring more statistical arbitrage traders to the listed markets and volume will beget volume.
Reg NMS will stimulate increased use of aggregation tools and algorithms among market participants.
However, it could be quite complicated to demonstrate you've complied with the mandates of Reg NMS.
If the burden of proof that you have followed the procedures rests with the broker-dealers, that could have an adverse effect on the number of people who can supply automated trading solutions. Today, if somebody wants to open a DMA firm, they can become a broker-dealer, work with a correspondent and get up and running pretty quickly.
If, in the future, you have to store all of your traffic, your tick data, [routing destinations]… And if you can't rely on exchanges through this inter-market sweep, then there may be fewer vehicles for the institutional investor to turn to for DMA services.
So, we would expect to see more usage and potentially fewer providers. But that second part could be avoided if [the act of] demonstrating compliance is something that is manageable by the mid-sized and smaller broker-dealers.
Eric Goldberg, Portware
On the face of it, this responsibility [for compliance] seems to fall on the exchanges. But all of the brokers I've been speaking to are concerned they're going to end up having the ultimate responsibility for their clients' orders. So they're in a big rush to figure out what has to be done. It all comes down to compliance. If you can store all the data, send your orders and electronically track where the market was to prove you're doing the right thing, I think the world's going to move very, very quickly towards fully electronic, probably algorithmic trading.
Everyone's going to have to use an aggregator of some sort because you have to know every quote that's out there in the marketplace at any destination. It brings up a lot of other issues. You're forced to pay exchange fees to all of these exchanges that are going to be popping up, and you have no choice but to get that data and use it. So you're going to end up doing a lot more electronic trading. I just see a big move in that direction. Everyone seems to be gearing up towards handling that.
George Hessler, Lava
Let's face it. The electronic trader has just acquired a brand new sandbox, and that's listed. Whereas a year ago you could have sent all your orders to New York, you just won't be able to do that.
The broker-dealer has a choice of whether to (a) abdicate that [compliance] responsibility by sending it to an exchange and then [letting] the exchange route out or (b) through the intermarket sweep mechanism, they can take on that responsibility across several venues. I don't think broker-dealers want to do that individually. So, yes, they're probably going to go to aggregators. They're going to go to third-party firms that can do that.
Joe Sommer, UBS
There's complying with Reg NMS, capitalizing on Reg NMS and sweeping. Since Reg NMS speaks to the top of the book, all you need to do is take out all of the orders at the top of the book. But as the rule says, that's not best execution. What do you do with the depth of the book? I think you're going to need independent aggregators of order flow to sweep the markets in ways that allow you to get more done beyond the compliance aspect.At better prices. And you're also going to want an ability to determine where to post to get the best fills, the best prices and likelihood of execution. So there's meeting the rules, and then there's working in the new market structure most effectively.
I think you're going to want independent third-party solutions such as Lava, UNX and other firms to be able to access those markets. Because when you rely on an exchange itself to do the routing, it will have an inherent bias to trade internally. Therefore, as broker-dealers, we're going to be partnering with those firms and building our own technology that allows us to capitalize on aggregate order flows in ways that best serve the institutional client base as well as the retail client base.
