Let the honeymoon begin! The New York Stock Exchange and Archipelago have not only tied the knot and merged, but they have further joined their bonds in unity through the fresh issuance of NYSE Group stock: symbol NYX.
Roughly 10 days before St. Patrick's Day, the leaders of the new NYSE rang the opening bell. They were their own guests of honor as the new stock began trading. The Big Board and Arca, as it's called, haven't always been the best of buddies. And that morning, a visitor might have confused lower Manhattan with the Bronx, as a chorus of jeers were sent the way of the smiling dignitaries overlooking the historic NYSE floor. The triumphant look on their faces only foreshadowed a brilliant first day performance for the stock. It jumped more than 25 percent. High-fives were in order, making for a lot of happy former seatholders.
Who would have blamed them if they had popped some bubbly right on the spot? Some 16 months ago, a seat sold for $900,000. On the first day of trading, the value of the equivalent in new stock was worth about $6.3 million. NYSE CEO John Thain might just be the seatholders' newly anointed Patron Saint. The Gospel according to St. John has blessed them financially. St. Gerard-former Arca head Gerry Putnam-might not be far behind.
Evolving
Traders on the floor, however, have another story. They admit to anxiety because of technological innovation and a new trading system that is being rolled out to the floor. Change is never easy. Final implementation of the NYSE's hybrid model is expected to be complete by the end of June. When complete, hybrid will feature reserve and sweep functions, something totally foreign to the current manual NYSE auction process.
"We have to evolve," said one floor broker who asked not to be identified. "We want hybrid to work." This same trader said hybrid brings dramatic change to the NYSE. Technology is the reason. He said new technology "trickled" to the floor over the last 10 years. That is what makes adjusting to hybrid such an eye-opener. "Now we are playing catch-up," he said.
One NYSE clerk described the Big Board's transformation into an electronic marketplace this way, "It's two different worlds colliding."
The NYSE is the largest marketplace in the world when measuring the capitalization of the companies listed there. It is also one of the last exchanges to have a working floor using an auction market system. The NYSE is currently implementing a hybrid marketplace to become compliant with the Securities and Exchange Commission's Reg NMS. This rule is forcing all exchanges to become so-called fast markets, with automatic execution against quotes. The current auction rules on the floor on the NYSE have always rewarded reactive traders, but now under hybrid, traders will have to be proactive.
"There's a lot of uncertainty," the clerk continued. "We don't know what's going to happen because it's uncharted territory." Indeed, under hybrid, investors need to be represented in the specialist's book; otherwise, they will miss out on prints. The crowd will be an electronic one.
Still, with the new broker handheld, parity will continue as it always has, except it will just be done electronically.
The NYSE floor's hybrid pilot has 154 stocks that are involved in the first phase of implementing the new system. Brokers can now e-quote their interests in these stocks. Traders report this initial phase has gone as well as can be expected.
"If you're comfortable with the technology, e-quotes have not been a problem," reports Ken Polcari, a floor broker with Polcari/Weicker. There has been a broad mix of stocks in the pilot, Polcari said. This provides an insight into how stocks of varying liquidity characteristics will trade in hybrid, he said.
Joseph Benanti, who runs his own independent brokerage unit, said there is a learning curve for brokers to get up to speed using the e-quote function on their handhelds. "No one on the floor is afraid to compete," Benanti said. "Just give us the tools so we can."
Mixed Results
One house broker reported mixed experiences with the e-quote function. The floor broker, who declined to be identified, described much different experiences in two separate stocks.
Using his e-quote function, the broker described how he traded about 300,000 shares of Lexmark in a day quietly and anonymously. Lexmark is not the easiest stock to trade, he said, but the stock was stable, which allowed him to complete his order, getting good fills, he said.
Conversely, he was also in a breakout situation in Hewlett-Packard. The news was positive earnings. "There were guys totally confused," the floor broker said. Some of the traders in the crowd were unfamiliar with the e-quote rules, he said, meaning they thought they were on parity with the book. They were not on parity; they had not posted their interests electronically. Also, floor brokers haven't mastered the dexterity to work the handheld just yet, which made trading difficult in that situation.
Consequently, even though HP was in the hybrid pilot, traders reverted to their auction roots of open-outcry. "I would say a low percentage of the orders got executed through e-quotes that day," the broker said.
Breakout
When there is great interest in a stock, one with news that produces volatility, the floor broker said he doubted that brokers will use e-quotes. That's because it is faster and more efficient to trade verbally than it is to punch in the information into a handheld, he said. "When there's an active situation, trading still has to take place broker-to-broker," he added.
Another broker agreed. "There's just too many keystrokes to input for e-quoting an active stock," the broker said.
Besides the big-picture question how the floor is impacted by hybrid, there are other concerns about the hybrid system itself. Floor brokers can allow the specialist to see reserve orders. There's a display button on their handheld that permits this.
And depending upon the strategy, it may or may not be a good idea to expose the interest to the specialists. The driving factor in deciding whether to display would be the characteristics of the stock and what the client needs to get done.
But the floor broker doesn't have the same information or picture of the marketplace as does the specialist. The floor broker is guessing the supply-demand equation, unless he can get depth of liquidity information verbally from the crowd or the specialist. "Human intervention is still needed to find size," commented one floor broker.
Information at the point of sale, as well as price discovery though negotiation, is what gives the NYSE an edge over ECNs, according to Thomas Shafer, an executive at Van Der Moolen Specialists. Shafer was a panelist at a web seminar hosted by Traders Magazine (The seminar is available for rebroadcast at www.tradersmagazine.com.). "Pricing stocks is what we do best," Shafer said.
Still, to e-quote a stock, a broker needs to be within five contiguous panels of where the stock is traded. So there will be information flow from other brokers, explained Doreen Mogavero, a floor broker at Mogavero & Lee.
Floor brokers were quick to point out that hybrid rules as currently drawn up can be readjusted on the fly: It's a work in progress, so there will be tweaking. However, some observers say that's been a source of confusion for the trading community. There have been so many changes to the NYSE's proposal, that it's been hard to follow; hybrid has been a moving target.
Under Review
One floor broker said the five-panel rule is under review, and the probability is high that zones will be created instead. "Now that the technology has been developed, it doesn't make sense any more to have the five-panel rule," Polcari, the floor broker, said. Keep in mind, he added, the rules for hybrid were written 18 months ago. Regarding zones, Polcari said the big room, for example, might have six trading zones, while the smaller rooms might have three.
Still, the rule could benefit floor brokers, whom many thought might be bypassed in an electronic marketplace. This rule could lead to floor brokers specializing in certain areas, since they need to be close to the action to represent an order.
Conversely, some firms are concerned they will either have to hire more brokers or just use more $2 brokers. That was the concern of one broker whose client-base is institutional money managers. "I'm afraid I'll have to hire 25 brokers," he said.
One house broker at a major Wall St firm also addressed e-quotes-a popular topic of discussion in the Traders Magazine web seminar. A frequently asked question is about the five-contiguous-panel rule for brokers. That rule stipulates that if a broker is e-quoting through his handheld, he must be within the immediate area, or five contiguous panels from where the stock trades. The floor broker explained that one reason for the rule is to replicate as close as possible how brokers currently trade at the post. Another reason, he said, relates to knowing what is going on in a stock. "If I'm e-quoting, I should be in the general area," he said, adding that he would feel "uncomfortable" if his firm's brokers were permitted under the rules to e-quote from another room. He pointed out that if a broker leaves the five-panel area, the broker has the option to change the order to a DOT or CAP order, leaving the agency responsibility to the specialist.
When all is said and done, brokers and specialists will be able to layer their hidden interests up and down the book. Investors themselves cannot post hidden orders under hybrid: they need a broker to represent them through their reserve function on the handheld. That's different from an ECN, which lets traders enter their own reserve orders. For reserve orders, as the exposed portion of the order gets hit or taken, the unexposed portion of the order keeps replenishing the quote until the order is exhausted or cancelled.
Both upstairs and buyside traders, however, will have the ability to directly enter sweep orders to the NYSE book. The interesting twist here is that after the first price is cleared, all orders in the book get filled at the clean-up price. This feature offers price improvement to liquidity providers. There are mixed opinions on how frequently the sweep function will be used by takers of liquidity, since it will come at a cost. On ECNs, the quoted price is the price that investors pay or receive.
Choice
One theory is that "walking the book" will be the primary method of trading because traders won't sacrifice price for liquidity. Traders might pay up a few pennies in certain situations-or walk the book-but they aren't likely to blast through a stock's bid or offer in regular trading situations, the logic goes.
Most traders "pick" at the inside quote, according to a floor broker, agreeing with the "walking-the-book" argument. A veteran specialist concurred: "They don't want to pay up a penny now."
Change is rampant at the Big Board. For the first time in its history, the NYSE is a publicly traded company. Now it has stock to use as currency to make acquisitions or to expand into other asset classes.
It has also consummated its merger with Archipelago, a former heated rival. Arca had been a thorn in the side of the blue chip Big Board during the upstart ECN's rise. Despite its speedy executions, Arca had difficulty capturing NYSE market share because of the trade-through rule, as did the other ECNs. (Reg NMS extended that rule throughout equities.) But that didn't stop Arca from taking great pride in poking fun at the NYSE's specialists for their slow and self-serving dealing practices. This was done through print ads, as well as other media. Arca also endeared itself to NYSE critics when it penned a disparaging song about specialists entitled, "Joey the Specialist." But now they are on the same team, which only further proves that feelings rarely-if ever-get in the way of making money on Wall Street. To be sure, the NYSE-Arca alliance likely would have occurred out of necessity, anyway. Nasdaq's earlier deal to acquire INET essentially pushed Arca into the NYSE's arms.
Still, the merger makes for uneasiness on the floor. The rules for hybrid provide a place for both floor brokers and specialists. Maybe both could flourish. But no one really knows how this will shake out. In the back of a clerk's mind is the same worry that traders have throughout the equities business: The concern they will become obsolete because of technology. "My biggest fear is that clients will at some point say, Why do I need a broker? I'll do it myself.' "
