The timing couldn't have been better.
Two days before Nasdaq released its dismal financial results for the first nine months of the year, it announced Instinet would start posting its quotes in SuperMontage. Instinet's decision could prove a big shot in the arm for Nasdaq's beleaguered Transaction Services. The division has seen its revenues slump 40 percent so far this year compared to 2002.
Transaction Services which accounts for such key money-spinners as SuperMontage, NWII and ACT – is one of three business groups within Nasdaq. The other two, covering market data and listings, have also suffered this year, although not as much as Transaction Services.
NTS has seen its revenues sliced this year to $183 million from $302 million last year. This was due to a sharp reduction in shares executed on SuperMontage, trades reported to ACT and log-ins to NWII. The bloodletting occurred despite a drop in the broader market's trading of Nasdaq shares of only five percent.
NTS' poor showing is almost wholly attributable to moves last year by the three largest ECNs to snub Nasdaq's services in retaliation to its launch of SuperMontage. Declaring Nasdaq a competitor, they struck out on their own.
Instinet chose to post on the ADF and report to the NASD. Island chose to post on and report to the Cincinnati Stock Exchange. Archipelago aligned itself with the Pacific Stock Exchange.
Nasdaq soon felt the pain. During the first nine months of the year, the percentage of shares executed on Nasdaq fell to 17.6 percent from 27.9 percent. The percentage of trades printed at Nasdaq fell to 61.3 percent from 83.4 percent.
Instinet, which is merging its book with that of Island, will begin posting on SuperMontage on January 1. That should goose Nasdaq's transaction fees, but is unlikely to have much impact on ACT revenues. Instinet will not print to Nasdaq those trades done internally and, under a recent rule change, pays no fees for the automatic reporting of its SuperMontage trades.
NTS is now run by Chris Concannon, a veteran of Instinet and Island who is credited with spearheading the effort to bring Instinet back into the Nasdaq fold. Concannon was originally hired in May to head up overall corporate strategy, but was replaced in that role by Adena Friedman. Concannon, in turn, replaced Glen Wolyner as head of NTS. Wolyner left to "pursue other business opportunities," according to Nasdaq.
Traders Magazine technology editor Peter Chapman spoke with Concannon about the Instinet deal and the prospects for his 40-person group.
Traders: What did you have to overcome to bring back Instinet?
Concannon: The number one objection was the priority issue.
Traders: The rule that permits traders using SuperMontage to subordinate ECN quotes with access fees to those of market makers and order entry firms?
Concannon: Right. We eliminated that. Now ECNs have the same priority with auto-ex participants – a market maker or someone posting in SIZE. But they also had to agree on a cap of their access fees. Actually, they had both a market structure objection and an economic objection.
Traders: The priority issue was the market structure?
Concannon: Yes.
Traders: What was the economic objection?
Concannon: That was something we eliminated earlier in the summer. If someone executed against [an ECN's] quote, we would charge that party – the ECN – an ACT reporting fee. We eliminated that cost to participate.
Traders: At the time Instinet opted for the ADF it stated it did not wish to subsidize a competitor. Does Instinet not consider Nasdaq a competitor anymore?
Concannon: When Instinet asks its customers to post their orders on its book the customer wants to hear that Instinet will try to get that order filled. And that it will market that order wherever it can. And one big piece they are missing right now – just like we're missing Instinet – is our flow in SuperMontage. So, they are betting a customer order placed on their book will get a better fill rate by having it publicized in SuperMontage. Take Archipelago, for example. They route to Instinet all day long. Instinet allows them in because they provide liquidity. So, we're coming in to take out orders on Instinet. To Instinet that is a good thing. They want those orders filled.
Traders: Most of the largest trading houses these days have book aggregation tools such as Lava. Does it really matter to them if Instinet's quotes show up in SuperMontage? They get quotes from the entire market on one screen anyway.
Concannon: Not everyone has Lava. Plus there are instances, although rare, where even if you are using Lava, you may actually route through SuperMontage. And a lot of people will actually use SuperMontage to reach out to certain liquidity pools. There is order flow that Instinet will participate in. It won't be in SuperMontage without a doubt. There is also a speed issue. The order may get to Instinet eventually, but will it get there faster if they are in SuperMontage? It all depends. It depends on who originated the order. And why. There are a lot of different reasons why fill rates may improve.
Traders: O.K.
Concannon: The simple logic is – If I have an order, I want to market that order wherever I can. Because, logically, that will increase the opportunity for that order to get filled. The more you market your order, the more likely you will get a transaction against it.
Traders: Nasdaq market makers are big users of Lava and Lava-like tools. Will they get much out of this deal?
Concannon: Our goal is to increase the overall liquidity of SuperMontage, whether that is routed liquidity or posted liquidity. I want people to post. But I also want people to go there for an execution. Market makers have quotes in SuperMontage. They have agency orders in SuperMontage. The more attention drawn to SuperMontage…The more orders coming in for an execution, then the more likely they will get a fill as well.
Traders: Nasdaq is also partnering with Instinet to offer its smart routing technology. Will this be offered through the NWII front-end?
Concannon: Most volume comes into Nasdaq via API and not through a Nasdaq front-end. This would be a flag. The way we envision it… When you would come into Nasdaq you put a flag on your order. You choose whether you want proactive' or SuperMontage only.' Proactive' means route. Route' means take me to the best market. Without that flag you will come in and participate only in SuperMontage. But remember SuperMontage also takes you to a variety of different markets.
Traders: When will you offer smart routing?
Concannon: This is something we are looking at delivering in '04. We are trying to avoid putting a date on it. But I'd like to say Q1 of 2004.
Traders: Once you bring Instinet in, you'll still be missing ArcaEx. Any plans there?
Concannon: Yes. My goal is to get Arca in through a linkage. We are talking to Arca about a linkage. The problem is when you deal with another SRO – Arca is an affiliate of an exchange – you have to do it in terms of a linkage. When you are dealing with an ECN, you are dealing with a participant. It's a different arrangement. Under the terms of that agreement they would be available in SuperMontage. Just like the Chicago Stock Exchange is available in SuperMontage.
Traders: Their book will show up?
Concannon: Their top of book.
Traders: Then you are trying to negotiate the same thing you did with Instinet to post?
Concannon: It's a little bit different. Because Instinet comes in as a market participant they are treated just like anyone else. Arca comes in as an exchange, a UTP exchange, under our linkages.
Traders: So, it would be similar to the way the Chicago Stock Exchange's quote are handled. They would be seen.
Concannon: Right. Seen and available.
Traders: If you bring Arca in, won't smart routing be less significant? You'll have all the major liquidity pools posting in SuperMontage.
Concannon: SuperMontage has limited… SuperMontage essentially reaches out to all liquidity pools. But it doesn't do any specialized routing. There are a variety of things you can do in routing. You can route to different pools of liquidity. For example, if all prices are equal, then send me on your routing matrix to the cheapest pools first. So you can route based on the access fee. SuperMontage doesn't do that. That's an important point.
Traders: OK
Concannon: Right now, before we change the priority for the ECNs, [SuperMontage] asks whether the ECN charges a fee or doesn't. It doesn't ask the amount of the fee. Routers can take it to the cheapest first.
Traders: You don't route anywhere now. This is first step in opening up?
Concannon: Well, I think of SuperMontage as a router. If the [posted] order is an auto-ex order, it executes on the SuperMontage book. So, a market maker order or an order in SIZE… Those are all automatic execution orders. But, an ECN quote is subject to order delivery. So, SuperMontage is really routing to ECNs today.
Traders: You consider order delivery to ECNs as routing?
Concannon: They participate in SuperMontage. We deliver them orders. Then they execute their side and report it back. So, SuperMontage is very similar to a normal router, but it is not complete. With Instinet and Arca out, it's not a complete router. So, by adding those players back in, we complete the routing service of SuperMontage.
Traders: Then smart routing will just give you smarter routing?
Concannon: It actually adds logic to the routing. Logic that isn't subject to all the different SEC approvals. It will be outside the Nasdaq facility.
Traders: Will you route to the American Stock Exchange? They trade Nasdaq stocks.
Concannon: They don't have auto-ex. I can't execute against them electronically. They've talked about a linkage. But they won't have an auto-ex system in place until March.
Traders: You "route" to Chicago?
Concannon: No. Chicago actually participates in SuperMontage as an auto-ex participant. So they are actually putting in orders that are available for auto-ex.
Traders: You expect auto-ex from UTP exchanges.
Concannon: To trade in Nasdaq and not have auto-ex… You should not expect a lot of flow.
Traders: Nasdaq recently launched a pilot program giving market makers the ability to trade on SuperMontage under multiple MPIDs. Why do this?
Concannon: The Nasdaq market has historically been a principal market. Before the influx of ECN volume in the 1990s. It has slowly converted into an agency market. Now it is a mix. Market makers are still putting up large amounts of capital to move blocks for institutions. And trading as principal with retail flow. But another huge segment is doing a very healthy agency business. That includes the ECNs. Instinet has a very healthy agency business. They talk to the buyside and execute as agent in the marketplace. Look at firms like Knight. Knight is now a large institutional player. They trade both agency and principal. So, an agent working an order is looking to post it. He can post it in his quote or in an ECN. An ECN allows you to post it where it doesn't interfere with your proprietary trading.
Traders: So market makers need their own agency acronym?
Concannon: An agency quote allows the market maker to be a better agent. Right now, some ECNs are agent broker dealers. But the market maker is hampered because he has only one quote. That of his market maker cash desk. There is proprietary activity there. [The second MPID] allows him to be a pure agent. He can tell his clients: Look, I've walled off all this proprietary business. They will never see your orders. And I will post them into my agency quote.' It's a pure agency service. Something that market makers will find very valuable.
Traders: Today, market makers use ECNs to do that.
Concannon: They are using a little bit of both. They are still using their proprietary quote, but on some orders it would be preferable to have it agent only.
Traders: Will a second MPID result in a transfer of orders from ECNs to SuperMontage?
Concannon: I don't necessarily see a wave of order flow moving off of ECNs. Partly because there is a variety of pure agency brokers that post in a variety of different venues. In SuperMontage. In ECNs. They are competing with the traditional market maker desks. Institutions like the product. There has been a growing demand for it. Burlington, Sonic Trading, Pulse Trading. It's a very successful model.
Traders: So, much of the ECN activity is being done by agency brokers and not market makers?
Concannon: Right. There may actually be more of a shift of the intermediary than a shift of where the activity is getting done.
Traders: At the annual STA conference, Bob Greifeld said market makers should reach out to order entry firms? Why?
Concannon: Arguably OE firms are looking to post their order flow. Traditionally they have delivered order flow to both market makers and ECNs. There is no reason why a traditional market maker with an agency quote can't also post for them.
Traders: Greifeld also said market makers should represent Nasdaq to the buyside. The way Wave Securities represents ArcaEx to the buyside. Why?
Concannon: This is an important point. Arca, a competitor, has Wave. Not only do they go out and talk to the sellside community they also compete with them for buyside order flow. So Arca asks traditional firms to send order flow. But, at same time, they are going around them and talking to the buyside with Wave. Looking for that higher margin business. Nasdaq does not go to the buyside directly. Nasdaq will only go to the buyside through our members. The intermediaries.
Traders: In other words, market makers should approach the buyside in an agency capacity just as Wave does?
Concannon: Yes. Agent only broker dealer.
Traders: And so that flow doesn't go to Arca?
Concannon: Yes. [Greifeld] is also quietly reminding our customers that Arca competes with them.
Traders: Nasdaq's NWII has been in decline for years now. Does it have a future?
Concannon: We will continue to support NWII. There are a lot of users of NWII. It has many functions other than just as a trading platform. You will find it on trading desks where it is not being used for trading. For clearing or pulling reports, for example. So there are a variety of uses. You don't just pull it away.
Traders: Will Nasdaq replace NWII with a new front-end?
Concannon: We are always looking at how are services are being distributed. Execution services. ACT trade reporting services. We are always looking at how well they are being distributed. Whether they are being distributed directly by us or by third parties. It is nice to have a very competitive environment of third parties delivering our services. Look at the front-end space. The Lavas, the RoyalBlues. They are re-distributors of our execution services. It's a competitive and dynamic world. There is no one customer need. When you consider all the different types of customers you have to deliver a different front-end platform. Whether it is a buyside or a sellside trader. There are OMSs behind all those platforms. You can't deliver a single platform that makes all customers happy. So, it is preferable for Nasdaq to have this healthy vendor community to re-distribute its services.
Traders: Nasdaq intends to work more closely with vendors?
Concannon: We are working on a program to evaluate each one of those re-distributors. We are going to score them on how well they re-distribute our services. Gold, platinum, brass or silver. I'm not sure. We will have a list and score each one of those front-end companies. We will make that list very public. Encourage the competition. The list will be a major marketing tool for a lot of the front-end companies. We think that is a healthy way to manage our re-distributors.
Traders: Do you still consider access a core service?
Concannon: Access into these services is still a big part of our business. We have different access points. FIX is new. That is an access service. Our API is an access service. But each of those vendors. When they re-distribute. They come in through those access services. So the access services are still there.
Traders: So, are you going to build or buy a new front-end?
Concannon: When I look at NWII, I certainly conclude it needs enhancement. Whether we do it internally or through a third party, we'll continue to evaluate it. We haven't made any decision.
Traders: Thanks for your time Chris.
Concannon: My pleasure.
