Instinet's recent acquisition of direct access broker ProTrader caps a sweeping change in the electronic matchmaker's access strategy.
For the past few years, Instinet has been quietly uninstalling its dedicated terminals from traders' desktops.
Faced with an explosion in the number of order management systems, direct access applications and other electronic communications networks, Instinet has decided to permit its customers to access its services through intermediaries. It will no longer require them to connect through Instinet's proprietary software.
The move reflects not only the growth in the number of front-ends, but also in electronic trading destinations. Traders want equal access to Instinet's competitors. And those third party front-ends will give it to them.
Long the preeminent electronic alternative to Nasdaq for institutions and market makers, Instinet is now, in effect, one of the pack. It is still the largest, trading 200 million shares per day, but it now splits the market with a couple of dozen alternative trading systems. And its share of that market is declining.
Although Instinet's strategy dictates the disappearance of its signature blue screens, it is betting more traders will access Instinet.
"You will see a bigger presence of Instinet on people's desktops," said Jean-Marc Bouhelier, an executive vice president in charge of technology and product development at Instinet. "That presence will be through whatever technology the client wants."
All told, 3,100 Instinet customers worldwide access the broker via 18,000 screens. In the U.S., its 1,900 customers include about 700 broker dealers and most of the top 500 money managers.
Nasdaq market makers account for nearly 70 percent of the volume traded on Instinet's limit order book.
For years considered a closed system' whose only point of entry was through proprietary software and hardware, Instinet began opening up, circa 1998. It started by permitting some of the larger Nasdaq market makers and institutions to integrate its offering into their proprietary OMSs. In December 1998, it announced it would be accessible through third-party vendors. Today, traders can get to Instinet through systems sold by Eze Castle, Macgregor, Longview, FlexTrade, Lava Trading, NYFIX, Belzberg, Davidge, Royalblue, various direct access brokers and other ECNs. (They cannot reach Instinet through SunGard Trading System's BRASS order management system, although talks on possibly allowing this are ongoing.)
Instinet's biggest deal to date was the $150 million purchase in October of ProTrader, a direct access broker. ProTrader made its fortune offering daytraders and small hedge funds fast access to multiple ECNs.
Agency Broker
Instinet intends to offer the front-end to hedge funds and other institutional traders. As the Instinet book will be only one destination on the system, the move adds weight to the ECN's claim of being an "agency broker." It has long claimed to be a neutral broker and not an exchange.
However, nearly 80 percent of Instinet's revenues derive from internal matches on its limit order book.
Instinet subscribers can access other ECNs today through Instinet's smart order routing' functionality, but analysts do not consider it top drawer technology. Even Instinet's Bouhelier admits: "We were faced with the challenge of renewing our technology for some of our client segments."
Convincing those clients that ProTrader is right for them won't be a slam dunk for Instinet. Several other ECNs and direct access brokers are already promoting their direct access wares to the buyside. Direct access brokers are pushing especially hard since the collapse of their core market – the individual Nasdaq traders.
As for the ECNs, Bloomberg TradeBook has always been a strong No. 2 with the buyside. It is reportedly building a new front-end. BRUT, a popular ECN among market makers, has begun to chase institutional business. It will soon debut a new front-end built in partnership with TheBeast. Island and Archipelago are also targeting the buyside.
REDIBook is already popular with hedge funds. Also, it is part of the REDIPlus front-end now getting an aggressive push by Goldman Sachs, its new owner. Last year, Goldman bought Spear, Leeds & Kellogg, creator of REDIPlus.
If Instinet is bested by the upstarts, its revenues would suffer. It charges $975 (per month) for the first terminal and $475 (per month) for each additional terminal.
To a large extent, by purchasing ProTrader, Instinet is simply playing catch-up with other ECNs. They already have strong smart order routing functionality. "It's what you expect from an ECN," said Damon Kovelsky, an analyst at Meridien Research of Newton, Mass. "They all have it. It's part and parcel of being an ECN."
The buyside certainly isn't missing the point. "A single entry point is great," said Jeff Albright, head trader at Waddell & Reed. "But we don't have one. And because of that we don't feel like we are exposed to the whole environment." Albright's desk uses Instinet and TradeBook.
Integrating OMS
Dave Brooks, head trader at the Boston Company Asset Management, also would prefer a single point of access to multiple electronic trading venues. To that end, his desk has been entertaining overtures from Tradescape. The direct access broker is in the process of integrating with Eze Castle's order management system Traders Console. The Boston Company is a user of Traders Console. Tradescape also owns the ECN, MarketXT.
Integration with order management systems is essential to Instinet's buyside strategy. Of course that's true for any electronic brokerage hoping to win institutional order flow. "That's where the order flow resides," said Robert Hegarty, an analyst with TowerGroup.
An OMS is not a trading system per se. It is software that allows both the trader and the portfolio manager to keep track of orders and executions.
Bona fide trading systems – those that transmit and receive pricing data, orders and reports – must be able to integrate. As OMSs take hold on the buyside, all other systems must bow down before them.
Instinet, which announced its policy to integrate with OMSs about two years ago, currently connects to four: Eze Castle's Traders Console, Macgregor's Predator and MFTP, and Longview's Landmark. (It does not connect to products from Indata, Decalog, Thomson Financial, Charles River, Advent and SS&C.)
"It's a work in progress," said Bouhelier at Instinet. "But our policy is to be up and running with whichever order management system our clients use."
Integration makes the trader's life easier. "It's a problem when busy traders must move between their OMS and Instinet dozens of times a day," Hegarty said. "It's just easier to do it out of the OMS." The analyst adds that Instinet is trying to catch other ECNs that plugged themselves in long ago. Bouhelier considers Instinet's decision to subordinate itself to the OMS a sign of the times. "The world has changed," he said. "When Instinet started there was only one way to reliably deliver technology. You had to own every piece of technology from the client to you. There were no order management systems."
The buyside OMS industry has only blossomed in the past five years. And it has only been in the last few that traders have demanded connectivity.
Market data feeds have been around for a long time, though. Many of Instinet's subscribers simply want to view its pricing data. Those who also take in a market data feed from Reuters, Instinet's long time owner, must maintain two applications and pay two fees. That's about to change. Instinet is rolling out BookStream, a data feed that displays Instinet's full depth of book. It will be accessible over Reuters, 3DstockCharts.com and one or two other vendors. It will obviate the need for a separate Instinet application. The service is now live with 20 clients, Bouhelier said. "If their core [market data] platform is Reuters or something else, we don't want them to be unable to view Instinet data through that platform," he said.
Price data is at the heart of the Instinet repackaging on the sellside as well. Nasdaq market makers aren't as concerned about a single entry point as they already have one in SuperSOES. What they want is the ability to see every single quote on every single ECN. (That's known as the full depth of book and it is a very hot issue.)
The problem is the penny increment. Decimalization has sent the number of price points skyrocketing.
The Nasdaq montage, which just shows the best bids and offers, is no longer deemed sufficient. To appease its crucial sellside customer base whose volume helps attract the buyside (which contributes most of Instinet's revenues) Instinet is cutting deals with intermediaries. It has agreed to let Lava Trading, an aggregator of ECN data, to make its full depth of book available to Lava's dealer customers.
Instinet is reportedly in talks with Archipelago. Now, Archipelago publishes five levels of Instinet price data. Instinet wants the competitor to show its full depth, although it is unwilling to return the favor, sources say.
BRASS System
Instinet is also in talks with SunGard Trading Systems to offer access through the popular BRASS system. SunGard has announced it will also offer full depth of book for multiple ECNs over BRASS, but traders aren't holding their breath. They note they cannot even get full depth of book from BRUT, which is a part of UMA, the BRASS front-end.
Whether or not a deal with SunGard emerges, the trend is clear. The Instinet application is going the way of the DOT box. "At the end of the day, we want to make it easier for each of our clients to trade with Instinet," Bouhelier said.
Basket Trading Booms
Basket trading is booming and Instinet wants a piece of it. Early next year, Instinet will debut a system intended for its basket-trading customers – index managers and other quants. The system will replace the traditional Instinet platform on customers' desktops and allow them to "trade strategies on a global basis," according to Jean-March Bouhelier, executive vice president in charge of technology and product development at Instinet. Instinet is wading into an increasingly crowded field. FlexTrade, Bloomberg, Spear, Leeds & Kellogg, ITG and others all have systems on the market.
Chapman Named Technology Editor
Peter Chapman was promoted to technology editor at Traders Magazine. Chapman, who joined the magazine as a reporter in June 1999, will continue to specialize in institutional equity trading technology, follow the trends and spotlight the products in the vendor community. He will also continue to follow other non-technology topics. Chapman has played a vital role in expanding technology coverage at the magazine. As technology editor, Chapman will help formulate editorial policy on trading technology and pursue other opportunities in this area.
