Fresh Off Finalizing Its Redibook Merger, Archipelago Faces A New Set of Challenges
On the verge of launching its much-ballyhooed, all-electronic U.S.-equities exchange, Archipelago recently finalized its merger with Redibook, its one-time electronic-communications network rival. Jointly, the newlyweds have already decided to use Archipelago's matching engine for listed equities and Redibook's engine for Nasdaq stocks. However, that is only an interim plan, and the allies still must hurdle significant business and technology obstacles before they can make any inroads in their quest to steal market share away from the New York Stock Exchange and Nasdaq Stock Market.
Stuart Townsend, chief information officer of Archipelago, says the process of creating an exchange, that will initially trade listed equities, has been fraught with regulatory challenges. Through a Nasdaq-supplied interface, he notes, the Archipelago ECN has been trading listed securities for a while. However, the fully-automated ArcaEX exchange - which will eventually replace the Pacific Stock Exchange's equity trading floor - is subject to tougher rules, enforced by the Securities and Exchange Commission.
“Once you become an exchange, and you're subject to this SEC oversight and the general scrutiny, the software-development process becomes a lot more complex,” he says. “So there has been a tremendous amount of testing ... (and) we've certainly had to build interfaces to ITS, the Intermarket Trading System, for listed securities. In addition, we have to provide our quotes to SIAC (the Securities Industry Automation Corp.), because (our quotes) will be a part of the consolidated-tape authority.”
Townsend, who is also the president and co-founder of Townsend Analytics - the software-development firm that helped build the Archipelago ECN - says that it is important ArcaEX doesn't list too many stocks too fast. “There's a lot of new software and a lot of new functionality that people have to learn how to use,” he says.
ArcaEX decided to trade listed equities prior to Nasdaq stocks on its exchange because, by becoming an exchange, it believes it will have tremendous opportunities for growth. Today, Townsend says, Archipelago only accounts for between “1 and 2 percent” of the overall U.S.-listed equities volume, as opposed to 12 percent of Nasdaq's volume. However, by becoming an exchange, ArcaEX will not only get direct access to ITS, but, for the first time, will be able to have its quotes displayed in the national-consolidated-quote system - the real-time market-data platform that displays the prices of all ITS participants. “Today, we're trading listed equities through the ITS/CAES system, via a Nasdaq connection. But you never see the Archipelago quote represented in the NCQS .... However, (when ArcaEX launches), you'll see the Archipelago quote in the montage for listed securities. And that (will have) the same advertising impact as having your (national best bid and offer) up on the Nasdaq montage,” says Townsend.
While its focus now centers on getting listed stocks up and running on ArcaEX, he says, Archipelago expects to migrate all of its over-the-counter Nasdaq volume - including Redibook volume - to its exchange-trading engine prior to the end of 2002. Though the allies initially plan to use Archipelago's matching engine for listed securities and Redibook's engine for Nasdaq stocks, the goal is to “move all of the volume onto the exchange platform” as quickly as possible.
Capacity concerns, says Townsend, were the primary reasons Archipelago decided to take an interim, two-pronged approach to trading engines. “Everyone was concerned about trying to integrate such a huge amount of volume into the Archipelago matching engine, while (simultaneously) trying to launch a new exchange and build a new data center,” he says. “The timing was just not going to work. So the prudent thing to do was to use (Redibook's) matching engine for OTC stocks .... But as we bring the exchange platform up, we'll start migrating that volume back to the exchange platform, and we can do that, literally, a stock at a time.”
One of the advantages Archipelago believes its exchange will offer, over the Nasdaq and NYSE, is the ability to quickly route out orders to other markets when there is no internal match available for a buy or sell order in its engine. When an order comes into the ArcaEX matching engine, Townsend explains, the first thing the engine will do is seek a match from either a market maker or another end user. If there is an internal match, that order will get executed immediately. However, if there in no match, the engine will route the order to a “preferred list” of ECNs and market makers ArcaEX will have direct connections with, says Townsend.
“If an internal match is not available, we'll (search) for the other prices and locations that order could trade with. And we have a hierarchy (of those execution destinations), so we know which (destinations) ... will always respond, and never back away. Typically, those destinations are other ECNs, (including) Island, Redibook and Instinet. If they have volume, those markets will trade with us,” he says.
ArcaEX, which will feature an open, price/time-priority-driven limit-order book, is scheduled for launch prior to the end of March 2002, and will initially trade 35 listed stocks. The reason the exchange is going with a “soft launch,” says Townsend, is because Archipelago wants to make sure it has properly re-written its trading engine, which will not only be subject to exchange regulations but also must handle new order types.
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A Direct-Access Q&A with Stuart Townsend
Wall Street & Technology: Your company, Townsend Analytics, has developed RealTick, a popular direct-access trading system. What segment of the market do you think will represent the next frontier for direct-access vendors?
Stuart Townsend: I think it will be small-to-medium hedge funds and professional traders ... (as well as) private-investment advisors and wealthy individuals. And (direct access) will not only cover U.S. equities, but international stocks ... and other instruments. We currently (provide) direct access to futures and fixed-income and foreign-exchange instruments. We also have direct access to the major European exchanges. In the U.S., there is very little interest in that today. But in Europe, there's a great deal of interest in direct access. From RealTick, you can route to Eurex, Xetra, the Swiss Stock Exchange, the Milan Stock Exchange and the Barcelona Exchange - on the same screen that you're routing (orders) to the CME, NYSE and Nasdaq. Our European customers do all of those things on the same screen.
Wall Street & Technology: Is consolidation inevitable in this space?
Stuart Townsend: I don't think consolidation is inevitable at all. Modern technology, the Internet (and) low-cost networks ... make it far easier to develop very sophisticated applications than it was 15 years ago. So I think you will continue to see niche players, (because) there is no reason why they wouldn't continue to evolve. Some will make it, some won't.
Wall Street & Technology: What factors do you think will determine which direct-access vendors will survive and which will ultimately die off?
Stuart Townsend: Good ideas, to start with. Good programming and execution. Good development, and good business plans ... and, if you're a niche player, to stay in that niche (for a while) and resist the temptation to expand too quickly.
Wall Street & Technology: What do you think of the prospects of single-stock-futures trading?
Stuart Townsend: I'm personally pessimistic about the future of single-stock futures. That vehicle has (essentially) been available to people for years, and no one has used it. You can obviously buy and sell (equity) options, by buying a call and selling a put, and get the functional equivalent of a single-stock future. And no one does it today ... The only thing that you're gaining is perhaps the ability to short a stock. But I predict that because of the difficulty of shorting the underlying stock itself, that you'll see quite a premium on short-selling futures. And that, in fact, it will all work out in the end that (SSF contracts) will look just like stocks, and no one will bother to trade them. |
