Don't count out the ECNs just yet. Despite Darwinian consolidation among trading venues that is likely to leave the Nasdaq market with just two major players next year, hope apparently springs eternal amongst smaller market centers. Nasdaq itself, assuming its deal to acquire INET is approved, and Archipelago Holdings are expected to dominate a market that once supported a dozen ECNs.
The pending duopoly hasn't scared off the competition though. In fact, it has invigorated it. Current and prospective ECN operators say the market desperately needs more competition given the changed circumstances.
There are still three small ECNs operating today in the shadow of Nasdaq/Brut, INET and Archipelago. They are Direct Edge, owned by Knight Capital Group, Track and Nextrade.
They will soon be joined by a fourth. BATS Trading, owned by proprietary trading house Tradebot Systems, expects to launch next month.
The ECN, whose name stands for "Better Alternative Trading System," recently received funding from daytrader broker-dealers GETCO and Wedbush Morgan. All told, investors have sunk about $8 million into BATS.
Tradebot, based in North Kansas City, Missouri, is one of a new breed of broker-dealer. Along with its peers, ATD and GETCO, Tradebot grew up alongside the ECNs, providing them with liquidity on an automated basis. Tradebot considers itself an electronic market maker, posting bids and offers on the various ECNs.
Traders Magazine executive editor Peter Chapman spoke with Dave Cummings, BATS' founder and chief executive officer, about the new ECN.
TM: Why establish BATS?
Cummings: I felt strongly that the market needed more competition and that I could deliver an innovative product.
TM: Two market centers are not enough? How many do traders need?
Cummings: I believe the roll-out of Regulation NMS will unleash three to five new competitors that will innovate to gain market share.
TM: The current offerings of ECNs are too homogenous? You see an opportunity to do something different?
Cummings: We will start by offering fast and efficient limit order matching and outbound routing. BATS' performance will be similar to what people came to expect from Island. We need to first get a critical mass of broker-dealers connected. Beyond that, we have many new ideas about how to increase liquidity in the less active names.
TM: BATS will operate separately from Tradebot?
Cummings: Yes. A core group of Tradebot associates has moved over to help me start BATS. We will have completely separate management teams in place before we go live. There will be a clear separation between the two companies.
TM: Will Tradebot provide liquidity to BATS?
Cummings: Yes. I would fully expect Tradebot and companies like it to be major early liquidity providers for BATS. Our goal, however, is to build an industry-wide coalition that brings together many different broker-dealers with diverse business models. Lots of black boxes trading in a fishbowl is not too interesting.
TM: Tradebot will remove that liquidity from other market centers?
Cummings: Tradebot's business will not change much when BATS goes live. Except that they are adding BATS as a market center. INET, Brut and Arca are disappearing because of the mergers.
TM: Will BATS offer the traditional ECN fee structure where liquidityproviders get paid and liquidity-takers pay?
Cummings: Most likely, yes, but with a few twists. We are watching the existing players closely, and plan to price our product competitively.
TM: How much market share is attainable? Who are the likely customers ?
Cummings: A share of at least 10 percent to 20 percent seems to be available if viable new competitors emerge. With the past two years, Redibook, Brut and now Archipelago, Island and Instinet have been absorbed. We think a good portion of their subscribers will find the BATS product useful.
TM: How many shares per day does Tradebot execute?
Cummings: Tradebot does not release exact volume figures, but it has been as high as 3 percent to 5 percent of total OTC volume on some days over the past year.
TM: Does Tradebot trade listed securities?
Cummings: Yes. Especially the ETFs. We expect the listed business to pick up considerably after the rollout of NYSE Hybrid.
TM: Will BATS trade listed securities?
Cummings: Our intention is to be able to offer trading for listed stocks. Working through the regulatory approvals and industry plans may take a bit longer on the listed side though. Before Reg NMS is fully rolled out, trading listed off the floor will continue to be an uphill battle.
TM: BATS will fare better in a post-hybrid world?
Cummings: That's what we are focused on. The NYSE is attempting the impossible challenge of creating an electronic market structure that provides just enough structural advantages so the specialists can earn a fair rate of return. In other words, a market that is just a little bit rigged, but not too much.
TM: You will need to link to stock exchanges.
Cummings: Yes. We will offer outbound routing to other markets when they display better quotes. Some markets will be connected directly, while the less active ones may be connected indirectly.
TM: Thank you, Dave.
The ECN Honor Roll
ECN Born Died What happened?
1 Instinet 1969 Soon? Merging with Nasdaq
2 Island 1997 2002 Merged with Instinet
3 Archipelago 1997 Merging with NYSE
4 B-Trade 1997 2003 Became agency brokerage
5 MarketXT 1997 2002 Shut down by the SEC
6 Strike 1998 2000 Merged with Brut
7 Brut 1998 2004 Merged with Nasdaq
8 Attain 1998 2005 Bought by Knight
9 Nextrade 1998 Still independent
10 RediBook 1999 2002 Merged wth Archipelago
11 Globenet 2001 2002 Merged with Archipelago
12 Track 2002 Still independent