The American Stock Exchange often comes across as a creaky old ship in the securities markets-one that's been taking on water in recent years. Instead of developing a robust technology platform for equities, Amex watched electronic communications networks siphon off market share in its marquee exchange-traded funds. Its options market share also declined in the face of new electronic exchanges.
The NASD, which bought the exchange in 1998, never delivered on a promised $100-million investment to create a combined Amex-Nasdaq trading platform. In 2001 NASD decided to unload the exchange but couldn't find a willing buyer to see the deal through. Morale on the floor flagged. In November of last year, three top executives, including Salvatore Sodano, the exchange's CEO, got caught up in a Securities and Exchange Commission investigation of Amex's failure to enforce its options trading rules.
The run of lousy news hasn't helped volume. Amex's average daily equities volume for the first nine months of this year dropped 6 percent from last year's average while both the New York Stock Exchange and Nasdaq saw their daily volume increase. The New York now has 25 times Amex's volume. This past summer, Barclays Global Investors announced it would move 81 of its 82 Amex-listed exchange-traded funds to the NYSE by the end of 2007.
For the exchange that launched the first ETF in 1993, BGI's decision was a blow. "Our challenges are many," admits Neal Wolkoff, Amex chairman and CEO.
But Amex isn't capsizing. Instead, there's been a thorough changing of the guard, and for the first time in years, many feel the exchange is heading in the right direction.
Wolkoff, the former chief operating officer of the New York Mercantile Exchange, the booming energy and commodities exchange, took over the Amex reins earlier this year. The Amex membership last year bought the exchange back from NASD, and new management and blood reinvigorated market participants who had languished under the yoke of the NASD.
"There are lots of critics out there wondering why the Amex is even around," says Andrew Schwarz, founder of AGS Specialists, one of the largest specialist firms on the American Stock Exchange. "We have suffered through our previous ownership and the executive team that ran Amex into the ground for eight years. The question is, Did they do enough damage that Amex can't salvage itself?'"
The Amex's goal is to recapture trading volume, bring in more equities and ETF listings, and beef up the exchange's financial well-being. Pushed by customer demand and the needs of the new Regulation NMS environment, the exchange is aggressively pursuing a hybrid market structure. Front and center in this effort is a new, state-of-the-art trading platform called AEMI (pronounced AMY) for Auction and Electronic Market Integration. The platform will initially trade equities and ETFs, but has the capacity to trade all products.
AEMI will integrate fast, ECN-like trading with Amex's floor-based auction market. The combination offers automated markets while preserving the role of the exchange's traditional specialist and floor brokerage community in providing liquidity and dampening volatility in Amex issues. AEMI will be NMS-compliant. Incoming orders will be immediately executed by AEMI. Those orders that would otherwise cause trade-throughs will be routed automatically to away markets with the best quote if no Amex floor trader steps up to offer price improvement.
There's little doubt that the impending NYSE-Arca merger will forever alter the way exchange floors and auction markets operate. However, Amex's task is to shift to an automated market that reflects the exchange's market structure for small-cap and mid-cap stocks that need the capital and liquidity provided by specialists. "There are always people who want to buy Lucent and sell Lucent," says AGS's Schwarz. "But for Peapack-Gladstone Bank, for example, they're rarely present at the same time. The specialist needs to inject himself there to make an orderly market."
Critical Roles
Specialists and floor brokers will remain critical in the Amex world. Specialists will continue to offer two-sided quotes and have affirmative obligations to maintain a fair and orderly market in their securities. They'll manage auctions, offer price improvement and provide what the exchange calls "resident liquidity" on the AEMI electronic book at multiple price points. Market-makers for ETFs will also provide liquidity at various price points (ETFs on Amex are traded by market-makers as well as specialists).
So far Amex has taken a notably different tack toward specialist algorithms than what has been proposed at the New York and other exchanges. To avoid interrupting high-speed execution, says Wolkoff, Amex specialists won't have algorithms that respond dynamically to incoming order flow. Instead, specialists' and market-makers' proprietary algorithms will provide price improvement in the form of competitive orders that reside on the AEMI book. These orders will only be able to passively price-improve customer orders and are based on exchange-set conditions relating to the competitiveness of the specialist's or market-maker's quote. Wolkoff stresses that this approach will provide price improvement that's meaningful to customers at the same time as it structures the way specialists interact with incoming orders.
The AEMI platform is not a pure order-matching system. There are times when the auction market will intervene and auto-ex will shut down. When that happens, the Amex market in that security switches to manual mode and can be traded through and bypassed by order flow.
Auto-ex will be disabled if there's high volatility in a security or a trading imbalance. In the case of the former, this will occur when the parameter for a spread or momentum tolerance is breached. The tolerances, set by the exchange, not specialists, are intended to dampen excess volatility that could occur with sweep orders or when large orders enter the market. The specialist will then re-quote the stock or conduct an auction, typically within 10 seconds to two minutes. Wolkoff says he expects more than 95 percent of the exchange's transactions a figure he pegs as conservative to be executed in an automated mode.
Despite the planned changes, Amex still has an abundance of skeptics. Damon Kovelsky, a senior capital markets analyst at consulting firm Financial Insights, sees major challenges ahead for Amex on both the equities and options side. "There's an industry fatigue with the Amex," he says. "It has taken them years to come up with a definite plan." Kovelsky agrees that for less-liquid stocks, specialists may intervene to help find liquidity and keep the market trading in an orderly fashion, "but how much is that worth to people?" he wonders.
Some suggest Amex's efforts are too little too late. Harrell Smith, manager of the securities and investment practice at research firm Celent Communications, says the exchange is playing "catch-up" but has no competitive advantage over ECNs or the NYSE. He sees the NYSE's hybrid model as a stepping-stone to a more technologically advanced trading model likely to come from Arca. In comparison, "there's no other side of the river for Amex," Smith says.
Specialists Survive
Wolkoff disagrees. He doesn't think specialists will disappear as quickly as experts predict, if at all. He and Amex's board of governors also believe the hybrid will return order flow to 86 Trinity Place precisely because it allows the market to trade as it sees fit.
"We'll have a market that can handle any way an investor wants to trade," Wolkoff says. "If that's more ECN-like, fine, and if it's less, that's okay. Orders can be handled purely electronically or with human interaction."
Mike Epstein, an independent Amex governor, points out that one of Amex's strengths is its rich and fertile history of product development, particularly with ETFs and structured products. This commitment will continue. In terms of its operations, "Amex is essentially starting with a clean piece of paper," he says. "It has a whole new board, new management led by Neal [Wolkoff], and new technology not only the hybrid, but the surveillance piece of it as well." Epstein, a visiting scholar at the MIT Laboratory for Financial Engineering and former director of quantitative trading at National Discount Brokers Group, is a former NYSE and Nasdaq member.
Bruce Weber, a London Business School professor who focuses on securities markets and trading technology, agrees that Amex earned its Street cred as an innovative and nimble market. "Amex has been able to roll out new products quickly and create a floor crowd around the instruments that generate customer interest," he says. But, he adds, "it doesn't have deep pockets and its lack of fast-market technology has hurt its ETF market share."
Amex's hybrid is a critical component of the exchange's bid to recapture order flow that's been lost to the ECNs. "The volume they're fighting for is ETF volume," Weber says.
BGI's decision to move its ETFs to the NYSE may not ultimately have a drastic impact on Amex's volume in a post-Reg NMS landscape. With auto-ex, Amex will be able to compete aggressively for the trades if it chooses.
Still, BGI's decision stung. "I was shocked and disappointed," Wolkoff says. "I was shocked because things had worked out so well and Amex was clearly heading in a better direction with its technology."
Nevertheless, Amex retains a frontier mentality when it comes to ETFs. Since last December the exchange has listed 42 ETFs, including 27 PowerShares ETFs and nine new State Street ETFs. Wolkoff says the exchange will end this year with about 50 new ETFs, bringing the total number of Amex-listed ETFs close to 200.
"They're doing all they can with ETFs and that's a fair amount," says Gary Gastineau, a principal at ETF Consultants, a management and consulting firm. Gastineau, who helped develop new ETFs at Amex in the 1990s, notes that Amex has always worked aggressively to build trading volume and assets for its listed ETFs. "The NYSE is only beginning to do that and in terms of the breadth of services, can't really match Amex," he says.
The Amex decided to outsource the development of its AEMI technology platform in order to be ready with a fully automated market by the current Reg NMS implementation date of mid-2006. It is working with an as-yet undisclosed technology vendor in Asia to customize that company's existing trading application for the Amex. The platform, under development since April 2004, will be completed around the end of the year and rolled out in the first half of 2006.
Amex's Tent
Amex is overhauling several trading and support systems at the same time as part of its effort to provide cutting-edge technology to boost order flow across products. In addition to AEMI, ANTE (Amex New Trading Environment), the exchange's options trading platform, is being enhanced for functionality and performance. Amex plans to eventually allow remote market making for options to build order flow. BARS (Booth Automated Routing System), the trading floor application that brokers use, is being upgraded and enhanced to serve options, equities and ETFs.
Amex clearly is pitching its tent on the quality of its technology and its ability to differentiate its market structure from that of other exchanges. "We're playing catch-up but we're motivated," says independent governor Epstein. "We've learned a lot from our mistakes and other people's mistakes and the Amex is a new ballgame in town."