In a move that high- lights the evolution toward virtual stock markets, blending multiple dealers with central limit order books, a regional exchange is introducing technology that lets specialists make markets away from the floor.
The debut of BEACON REMOTE by the Boston Stock Exchange follows approval by the Securities and Exchange Commission in August, to extend Boston's BEACON trading system for specialists who choose to trade from their offices.
To that end, Boston signed an agreement with Savvis Communications to provide an IP network to link off-floor market makers to the BEACON data center in Woburn, Mass.
Beta testing of the new system began at "select" sites in September, according to the exchange. Charles Schwab & Co., a specialist at the exchange, confirmed it is operating one of the sites.
Despite the changes, Boston insists it's not abandoning its floor. Indeed, it only just moved to a prominent street-level location in early 1999 from the 38th floor of a Boston high-rise.
"We look at the floor as an investment in the town," said exchange president James Crofwell. "We invite in customers and students. We're committed to that."
Crofwell claims the plan is to bring in new blood that doesn't want to set up a floor operation. "This is a way to gather more liquidity from people who are elsewhere," he said. "We don't have enough to match up all the naturals. This will bring more specialists into the mix."
Others say the likeliest users are the large national broker dealers who use Boston to trade against their own order flow. Charles Schwab, Fidelity Investments, Morgan Stanley Dean Witter, Pershing Trading Company and Herzog Heine Geduld are the biggest of the exchange's 16 specialists. All are able to take advantage of a competing-dealer program established in 1994 to trade any stock they choose.
Charles Schwab is one specialist that eventually hopes to permanently run its posts on a remote basis.
"We will be involved in the beta testing," said Dave Herron, vice president of listed equities at Schwab Capital Markets and Trading. "Our [deployment] plans depend on how well that works. Transition takes awhile, though, and, as you know, traders hate change."
Schwab is no stranger to remote posts. It became a member of the fully-electronic Cincinnati Stock Exchange last year and subsequently closed its posts at the Pacific Exchange, its long-time home.
It handles its CSE trading from San Francisco and says it could operate BEACON REMOTE from there. Alternatively, it could operate out of its Jersey City trading room or other locations, the firm says.
Jersey City-based Herzog, on the other hand, has no plans to go remote. In addition to its floor operation it also runs an institutional brokerage in Boston. "It's status quo for us," said president Buzzy Geduld. "We've been on the floor for many years. It's a cost efficient way for us to operate." Geduld says higher telecom charges for long-distance trading is also a deterrent. Crofwell acknowledged they are a factor.
Fidelity, Morgan Stanley and Pershing Trading would not comment.
More Liquidity
A Boston floor broker believes the move will bring in more liquidity. As the big specialists move into their offices, new, smaller firms will take posts on the floor. "You have a lot of people on the floor who are trading their own order flow anyway," said Jim Yonchak, a floor broker with Ward, Conary & Murphy. "If they go upstairs and trade, then we have the room to bring in other people hungry for new order flow."
Space is apparently tight. "We still have a little bit of real estate available, but most people would squawk if you took the post right next to their elbow," Crofwell said.
Many of those elbows are down on the floor trading blocks. The institutional business is a big reason Boston's floor is still necessary. Most of its retail orders are executed electronically, but, like the New York Stock Exchange, Boston executes a fair amount of block trades.
Many of those trades require the human touch. "It is an advantage to communicate face-to-face if a floor broker has a block for sale," said Dan Joyce, head of capital markets at Boston specialist Moors and Cabot.
The average trade size at Boston is just under 1,000 shares, according to Crofwell. That compares to about 500 at its regional competitors the Pacific and the Cincinnati.
Blocks may not be enough to shelter Boston from the forces reshaping the country's stock markets, though. SEC pressure forced all exchanges to rescind their rules prohibiting specialists from trading certain stocks off-board. The big brokerages could decide to abandon Boston altogether and trade their retail orders in Nasdaq's InterMarket. That means Boston has to fight even harder now to hold onto those trades.
Or find new members. Crofwell said Boston is a cheaper alternative to Nasdaq or the Cincinnati for small shops that want to trade listed shares. Firstly, the BEACON REMOTE front-end is free with membership. A firm would have to rent, build or buy one to operate on Nasdaq or the Cincinnati, according to Crofwell.
Crofwell also touts the exchange's surveillance program: "We spit out a lot of data that they can't get from a third party-on execution quality, for example." Finally, he says Boston's full clearing services would appeal to smaller firms.
"We're trying to reach a wider audience now," Crofwell said. "There are people who don't have a turnkey [trading system]. We've positioned this as a full-service turnkey venue with a very low cost structure."
Boston's move is in line with the trend towards virtual markets in the U.S. Competing dealers transacting remotely with each other coupled with a central limit order book or CLOB, is the operative word at Nasdaq, the Cincinnati and the Pacific.
In the early 1980s, the Cincinnati became the first virtual stock market using a CLOB. That's when it shut its floor and instituted a competing-dealer program on a remote basis. Specialists make markets in any stock they choose from their offices. Limit orders, not immediately executed, are posted on the book in the CSE's National Securities Trading System. The scheme is popular with retail brokerages like Charles Schwab which internalize their own order flow at their posts.
The Nasdaq market adopted the model by default in 1997 after the SEC's order handling rules gave birth to electronic communication networks. The nine systems have become a de facto Nasdaq CLOB, "enhancing" what was already a virtual market with competing dealers. Nasdaq has tried for several years to win SEC approval for a CLOB of its own. It may get its wish if the SEC approves supermontage.
The Pacific, meanwhile, is in the process of closing its two floors, inaugurating a competing-dealer program and merging with the Archipelago ECN. The ECN's trading system will become the exchange's CLOB, replacing the P/COAST book.
Like the Pacific, Boston also wants a new CLOB. It is entertaining bids from a handful of technology companies-reportedly OM Technology, the builder of BEACON; IBM; and Canada's EFA-to replace the CLOB's order matching engine. Boston currently operates in the old Stratus proprietary VOS environment. It wants to upgrade to a more open system.
"There's no immediate need," Crofwell said. "We're trying to plan and get it right. We intend to replace it over the next year or two."
Lack of Funds
Unlike the Pacific, however, Boston lacks the money. Its chairman, William Morton, told The Wall Street Journal that he hoped to sell a minority interest in the exchange to a company with information technology expertise. That would make funding available for a revamp of BEACON. Talks were held with Bridge Information Systems and Bloomberg and follow a failed merger with the Cincinnati.
Cincinnati chief executive David Colker told the Journal an obstacle to a deal was Boston's "traditional floor culture." Now, however, if BEACON REMOTE works as planned that may no longer be the case. "If we find out in two years that all the specialists decide they want to go remote then guess what we'd do?" Crofwell asked. "We'd close the floor."
