Most traders want to level the proverbial playing field on Nasdaq. Only no one can agree on how to do it.
Buy-side traders want limit-order protection, price transparency and a more-centralized market. Broker dealers and market makers complain about unfair competition from electronic communications networks (ECNs) and day traders.
So first, the National Association of Securities Dealers' introduced its NAqcess proposal, a failed small-order execution system. Then there was the recently-shelved limit-order book, which would have provided a central facility for the execution of limit orders.
Now it's the so-called agency-quote proposal.
The NASD hopes its newest proposal for the handling of limit orders allowing market makers a second quote for agency orders will satisfy both buy-side and sell-side traders, while maintaining access, choice and transparency in the market.
But many traders on the buyside and sellside, while supporting the new agency-quote proposal, do not feel it's a permanent solution.
"I don't think it's a long-term fix," said George Jennison, head of Nasdaq trading at Wheat First Union in Richmond, and a former member of Nasdaq's Quality of Markets Committee. Jennison recently completed a three-year term on the committee, during which time the NASD designed both the limit-order book and the new proposal.
"It seems like another step," Jennison added. "It doesn't smell like a long-term solution. It's hard to believe having two different quotes will solve all the problems in our market."
Bart Green, manager of over-the-counter trading at Edward Jones in St. Louis, also feels the proposal is just a small step toward improving the market.
"There is probably a better way of doing things," Green said. "It's a positive proposal when you compare it to the current market. But doubling the number of quotes could muddy the waters."
Both Jennison and Green like most sell-side traders are at least satisfied the new proposal has replaced the limit-order book, which would have competed with market makers for orders.
Many buy-side traders, on the other hand, favored the limit-order book, and were disappointed with its failure.
"I was in favor of the limit-order book," said a buy-side member of the Quality of Markets Committee, who requested anonymity. "The buyside wasn't vocal in supporting it, and the sellside made their voices heard. The agency-quote proposal is just a step. I still hope Nasdaq gets some reasonable facsimile of a limit-order book."
Harold Bradley, a portfolio manager at American Century Investment Management in Kansas City, and a buy-side member of the Quality of Markets Committee, blamed many market makers for the failure of the limit-order book.
"Market makers are trying to preserve their economic self-interest," he said. "They all want to roll back the clocks and trade the way they've always traded. But they ought to figure out what's best for the market."
The Proposal
As currently envisioned, the agency-quote proposal would allow each Nasdaq market maker to publicly display agency orders to the market in a second quote, separate from the market maker's proprietary quote.
Firms would establish a second acronym or market-maker identifier in stocks in which the firm makes a market. One-sided agency quotes would be allowed, and any customer order could be included in the second quote, including institutional-sized orders. Agency quotes would be automatically executed through the Nasdaq system.
Currently, when a market maker places an order in the market, it is displayed in its public quote with the acronym MM1, for instance. Under the order-handling rules, a market maker is forced to either display a better-priced agency order in its proprietary quote, or place it in an ECN.
A market maker does not charge an access fee when its quote is hit in the market. But when a market maker hits a quote in an ECN, on the other hand, the ECN can charge a fee.
The new proposal would effectively provide each market maker with its own mini-ECN to display customer orders. The market maker would be allowed to post two quotes a proprietary quote, or MM1, and an agency quote, or MM1A. The best-priced quote would be given priority, and the market maker would not be allowed to trade ahead of a customer order.
The Securities and Exchange Commission does not currently allow market makers to charge access fees. But under the agency-quote proposal, market makers would likely be given the option of charging fees to counterparties accessing their agency quotes, putting market makers on equal footing with ECNs.
The Charges
But adding fees on Nasdaq is potentially a controversial issue. A third buy-side member of the Quality of Markets Committee, also requesting anonymity, expressed concern about the fees.
"The ECNs charge access fees, and the SEC supports that. The dealers can't charge fees, and they say it isn't a level playing field," the committee member said. "But if Nasdaq moves to add fees under the new proposal, the market will be more expensive, and that hurts competition with other markets. And it's the buyside the eventually has to pay the fees."
But Jennison said the new fees could create a system of debits and credits for order flow, which would effectively neutralize access fees.
"It will be an educational process," said Bernard Madoff, chairman and founder of Bernard L. Madoff Investment Securities. "All market makers will charge or none will charge. Competition will keep fees reasonable to compete with ECNs."
The Integration
Tied to the proposal is a measure to integrate SelectNet and the Small Order Execution System (SOES) on an interim basis.
SelectNet would be converted into a non-liability system for order delivery and negotiation only. Orders would be sent through SelectNet only if they exceed the displayed quote to which they are directed by at least 100 shares. Recipients would be allowed but not required to execute against the orders.
With some modifications, SOES would become Nasdaq's new execution system. The maximum-sized order would be increased from 1,000 shares to 9,900 shares, and market makers would no longer be prohibited from using SOES on a proprietary basis. The 17-second delay between executions against the same market maker would be reduced.
The NASD approved 90 percent of the proposal in a December 11 meeting. The rest of the proposal, concerning the fees market makers may charge for accessing agency orders, was approved by the NASD in a January 21 meeting.
The proposal is subject to final approval by the SEC.
The Approval
Madoff, one of the most outspoken opponents of the limit-order book, supports the agency-quote proposal.
"I don't think anybody will have a problem with it," he said. "The biggest problem with the market was the ECNs charging fees, while the market makers couldn't. This proposal, as filed, is completely fair, and it's something everybody can stand behind. This solves it."
Others are not quite so sure.
Jennison, while generally supporting the proposal, thinks it will further fragment the market. "What's crazy is the doubling of quotes," he said. "If I was a buy-side trader, I would think it could get confusing to see two markets posted for every firm. The fragmentation of the market is something that still needs to be addressed."
Paul Pantalena, head trader at money manager Columbus Circle Investors in Stamford, said fragmentation should be avoided. He supported the limit-order book because of its proposed centralization of Nasdaq.
But he's not looking at the agency-quote proposal as a possible solution.
"I'm sick of Nasdaq proposals," he said. "When it's close to reality, I'll get more interested in it. Nasdaq is a changing market. They've proposed a lot of things that never came to fruition. I'm in favor of anything that will centralize order flow and make quotes accessible. But it remains to be seen whether that will happen."