Sellside stock execution services today are a bit like loss leaders in the 99 cents store. The commission rates are dirt cheap but the quality can easily become questionable. These low rates, undoubtedly, are hurting many Nasdaq dealers and ECNs. But the pain can only last for so long. Don't be surprised if commission rates eventually start to rise. That moment hasn't come but some must be hoping it happens soon. Running a charity for buyside institutional investors – a group that rarely has a kind word for the sellside – is not fun. The buyside's constant whining is enough to turn your stomach. Market makers were hammered by penny increments. And the ECN execution business is another low-margin affair, as Instinet CEO Ed Nicoll reminds Traders Magazine's Peter Chapman in the Cover Story. Instinet, for instance, now charges the buyside about 1.5 cents a share. This pricing pressure has repeated itself all through economic history in other industries – many times driven by the same economic, regulatory and technological forces. And the pressure is felt right now across a wide spectrum, including telecommunications, electronics, publishing, food and apparel, travel and leisure. It seems plausible that, in the absence of some radical regulatory changes in the historic broker dealer role of intermediaries, there will be a stunning collapse of the sellside execution business. Alternatively, there will be consolidation of monopolistic proportions, or else – more likely – warning signs of impending disaster. This could force the regulators to approve new forms of fixed commissions.
The recent report of a potential merger between the New York Stock Exchange and Nasdaq is a warning. Another warning is the lobbying these past months in Washington by ECNs for trade through rule reform. Yet, in one sense, the ECNs are grasping at straws for their very survival. Most probably, only access fees are keeping the wolf from the ECN door. The SEC, unsurprisingly, is carefully weighing whether to open the floodgates for listed trading. In a new liberalized trade through environment, would an NYSE and Nasdaq alliance make sense? "I told my clients it would be like two seagulls fighting over a freedom fry in a McDonalds' parking lot," sniffed one executive at an electronic trading service. In other words, the NYSE and Nasdaq would be left to handle trading in most of the illiquid stocks while the ECNs feast on the larger cap names, the sort saturated in liquidity. Nasdaq's own market in listed trading – and the entire third market – might be decimated. On the other side of the trading fence, stand some ungrateful institutional customers, looking for even cheaper execution services, as if that's practically possible. Unfortunately, they could get exactly the opposite: rising commission rates. In the end, of course, the SEC will likely rule in favor of its most important constituency: the individual investor.
John A. Byrne