How a Sleepy Broker Became a Global Giant: Instinet Started Small and Grew Up To Shake the Establish

Instinet was once a sleepy U.S. domestic broker. Not anymore.

It now spans the globe, executing buy and sell orders electronically across international borders a far cry from the system first conceived as a computer network for institutions trading New York Stock Exchange-listed stocks.

Back in the early days, life was different. During Instinet's first 14 years, in fact, volume grew at a snail's pace. Then times suddenly changed. And in 1983, Instinet took the industry by storm when it began trading Nasdaq stocks. Business grew spectacularly.

Four years later, bigger changes were afoot. Instinet was acquired by Reuters Holdings PLC, the British news and information giant. Among the new owner's boldest moves: giving customers the ability to cross stocks anonymously with each other. That move worried Nasdaq.

Now, institutional accounts and others, trading with each other or directly with the broker, paid a commission to Instinet and part of the bid and asked spread, rather than the full spread made by the market maker.

Trading on Nasdaq was being partly disintermediated because investors could trade between the spread, and market makers were no longer making the difference between the bid and asked price on each trade. That didn't stop market makers using Instinet to lay off their positions, however.


When Instinet added anonymity in April 1989, some clients actually canceled their accounts. Anonymity meant that a trader could no longer avoid paying commissions on some orders.

Buying 25,000 shares, for example, the trader could no longer enter an order for 1,000 shares, wait and see who took the other side and then phone that party to trade the other 24,000 shares. (Instinet now charges pennies or less on shares of the U.S. trades it executes.)

Some say Instinet's maneuvers were prescient. Today, trading among customers between the bid and asked spread is explicitly approved under the Securities and Exchange Commission's order handling rule. What's more, anonymity and the lack of market impact are viewed as Instinet's main attraction to traders. Back in the 1980s, however, that caught Nasdaq off guard.

Nasdaq's parent, the National Association of Securities Dealers, fought back with its own private network, an upgraded SelectNet. Instinet now competes with Nasdaq for order flow, and reportedly accounts for 20 percent of Nasdaq volume, the equivalent of more than 100 million shares daily. Instinet enables a Nasdaq market maker or buy-side trader to select each stock's page on their Instinet terminal. The user can then anonymously hit a bid, enter an ask or negotiate with a buyer to raise the bid between the spread.

Two years ago, the last time reliable figures were available, Instinet had an estimated 5,200 customer terminals worldwide. In theory, Instinet is open for real-time trading 24 hours each day, 365 days a year. In practice, Instinet volume in a stock declines at night once that stock's primary market has closed, with activity surging during important world events.

Global Markets

Today, Instinet is taking on the global markets. A registered broker dealer in 16 countries, and correspondent relationships with brokers in others, Instinet trades in 40 markets. Foreign customers now account for an estimated 70 percent of Instinet's global business, up from 25 percent in 1992.

Instinet's fastest growing customer-segment is European fund managers trading securities across national borders, according to Doug Atkin, executive vice president of Instinet and chief executive of Instinet International.

These European managers use Instinet whenever they forego the primary markets to trade their stock on the international marketplace. Foreign customers account for about 75 percent of Instinet's global business, up from about 25 percent in 1992. "Instinet's global business will equal its U.S. business in three years," Atkin said.

The global push dates back to Instinet's acquisition by Reuters. The new parent's first move was to open an outpost in London to attract U.S equity order flow transacted out of London on SEAQ International, the lightly-registered screen-based wholesale market for broker dealers trading large amounts of foreign stock. SEAQ is run by the London Stock Exchange (LSE).

By 1992, Instinet embarked on another mission: establishing direct electronic connections to the major European exchanges, including exchanges in Paris, Frankfurt and Zurich. That meant clients could access the exchange floors directly. "The mid-sized U.S. broker dealer that wasn't a member, could use an Instinet terminal to execute overseas," Atkin said.

Next, Instinet gave foreign fund managers and brokers the ability to trade across national borders. Brokers could trade stocks not listed in their home country through a central source of liquidity, Instinet, as distinct from sending orders for the same stocks to brokers based in the primary markets.

On one terminal, the broker could access global markets and pay a commission, settling each trade using Instinet. Consequently, some say Instinet was bringing liquidity to the global markets. When the system can draw French and Asian customers to the Dutch market, "Instinet is a friend of the local broker," Atkin said. "It doesn't compete with their core business."

Crossing Sessions

Instinet International performs some crossing sessions. In the U.K., the cross is scheduled up to seven to eight times each month. The Japanese cross takes place every two weeks, or more frequently if necessary. Atkin views crosses as a natural extension of trading, but stresses that relying exclusively on crossing is a mistake.

That's because a major source of liquidity on international orders comes from trading upstairs. For example, with an order to buy one million shares, a client may send a piece to a French exchange, another to Instinet to buy from a natural counterparty and the balance upstairs, where an Instinet sales trader acting as an agent may find an institution willing to sell.

Another example involves lists of stocks traded across several markets. Instinet sometimes receives four or five lists or program trades daily, each valued at more than $20 million, executed by Instinet as an agent for a charge of perhaps ten basis points.

Recently, Instinet received a $500 million order from an Asian fund manger to trade more than 400 stocks across 25 markets. First, Instinet performed a pretrade analysis to determine which stocks would be most difficult to execute, and then filled the order. The client said it was one of his best trades, Atkin claimed. "That combination of local exchange-liquidity and the ability to trade upstairs is what's driving the business," he added.

Here's a peek at what's happening across the globe for Instinet:

Australia The land Down Under has one national exchange, the electronic-based Australian Stock Exchange. The Aussies, however, denied Instinet membership on its exchange two years ago because it didn't recognize Instinet as a broker dealer. That may be about to change. Instinet's Atkin said the current atmosphere for membership is more hospitable.

JAPAN Instinet hopes to join the Tokyo Stock Exchange within the next two years. Since other Asian markets do not allow electronic trading, Instinet operates in these markets like a conventional broker, communicating by telephone.

London Instinet competes with SEAQ on the LSE. SEAQ has about 50 registered international dealers making markets in international stocks.

(Foreign companies listing with SEAQ totaled about 1,000 in 1997, up from 550 in 1990. These include such large, liquid issues as General Motors, IBM, Royal Dutch Petroleum, Deutsche Bank and Siemens.)

On Oct. 20, 1997, Big Bang II thundered through London and trading in the U.K. was impacted. At the LSE previously a quote-driven dealer market an order-driven central electronic limit order book, the Stock Exchange Trading Service (SETS) was introduced. SETS is used for stocks in the FTSE 100, an index of the LSE's 100 top-performing stocks.

SETS plans to add 250 more stocks this year. An LSE spokesperson noted that a quote-driven market may be better for less liquid shares. The spokesperson added that there are no plans to expand SETS over the 350 largest stocks.

Atkin said that Instinet is the only broker dealer that provides customers with the ability to send orders directly to the SETS order book instead of by telephone.

How's Instinet business since the Oct. 20 bang? "Booming," gushed Atkin.

An Offshoot

International electronic trading is a consequence of the globalization of equity markets.

A Greenwich Associates' survey of more that 100 institutions in the U.S. revealed that the number using electronic systems to execute non-U.S. trades grew to eight percent in 1996, up from three percent the previous year. Sure, there are troubled economic spots that fund managers avoid.

Still, for growth and diversification, many have satisfied their portfolios outside the domestic markets and want more international trading action.

Buyside and sell-side traders use electronic trading systems to execute orders for foreign stocks, in part to minimize transaction costs.

Beside Instinet, other players on the international scene include New York-based ITG's POSIT, the Portfolio System for Institutional Trading, a crossing network jointly launched in 1987 by Los Angeles-based Jefferies & Company and BARRA, a California-based software and investment research firm. ITG typically forms alliances with local partners to penetrate foreign markets.