Two sides to every story
The SuperMontage debate
By Jeff Ponczak
SuperMontage, Nasdaq’s proposed order-execution system, has been a source of controversy ever since it was announced late last year (see “NASDAQ proposal not so Super to ECNs,” Active Trader, September, p. 15). While the NASDAQ and many leading market makers think it will end what they perceive as fragmentation in the market today, certain ECNs are vehemently opposed to it, claiming it is anti-competitive. Congress has raised doubts as well, and the Securities and Exchange Commission (SEC) is still considering its approval.
In late September, NASDAQ made major modifications to SuperMontage that, among other things, allows users to choose the route they want their trade to take. Those changes appeased Bloomberg Tradebook, an ECN that previously was against SuperMontage. However, opposition to the proposal still remains.
So much has been said and written about SuperMontage, it’s often difficult to keep track of who stands where. To simplify things, Active Trader asked market participants on opposite sides of the issue to voice their thoughts on SuperMontage.
Defending SuperMontage are Bloomberg Tradebook and NASDAQ, while Joel Steinmetz, senior vice president of equities at ECN Instinet, offers the anti-SuperMontage side. Both sides were asked identical questions and their responses follow.
Since the NASD planned to have less than a controlling stake in NASDAQ as of November (because of an ongoing demutualization), is the “my-regulator-is-my-competitor” argument still a valid one?
PRO:
No it is not. That issue is part of the reason NASDAQ is separating further from NASD. By the completion of the second phase of the private placement, NASD will hold a small, minority position in NASDAQ and NASDAQ will be an independent organization with its own board and management. Robert Glauber became CEO of the NASD on Nov. 1. Frank Zarb continues on as CEO of NASDAQ Second, NASDAQ is not now a competitor to ECNs, nor will it be one in the future unless an ECN obtains status as an exchange. Unlike market makers and ECNs that execute orders as agents or principals and are compensated based on the value of those orders, NASDAQ never takes a side in the execution of an order. Rather, NASDAQ routes orders and executions between market participants. NASDAQ runs the railroad. It is not the only railroad. And it is not a train that runs upon the railroad.
CON:
Yes. There are two main issues. First, orders from market participants are not forced into NASD; they are forced into NASDAQ’s quote montage. That does not change with NASDAQ’s structural change. Our orders are still “regulated” into NASDAQ, who is creating a competing system.
Second, [NASDAQ and NASD] are still perceived as one and the same. Therefore, market participants seeking to fulfill best execution requirements would probably feel more comfortable achieving those on a system that is not connected with the regulator of that requirement both in name and ownership.
Do the latest amendments to SuperMontage address the concerns of ECNs who claim their access fees are being unfairly considered when it comes to placement in the order book?
PRO:
As proposed in Amendment 8 [which cancels unexecuted marketable limit orders if they are not immediately filled], yes. Rather than a biased price-time execution sequence that would favor either market makers, ECNs or UTPs (Unlisted Trading Privileges Exchanges), market participants and investors will have a choice of execution sequences. Market participants and investors will be able to design their own best execution algorithms by preferencing market participants of their choice. The NASDAQ default execution sequence will be a neutral price-time priority regardless of market participant, order delivery (SelectNet) or execution (SOES) recipients, or access fee charges.
CON:
The claim is not where ECN orders lay but rather what happens to investors’ orders. The latest amendment allows other market participants to trade around investor limit orders. In past amendments there was one way to do that. The latest amendment actually has two ways of achieving that! One can choose an algorithm that allows discrimination against certain types of limit orders, or the preferencing feature to trade around limit orders. Either way, investors’ limit orders can be traded around.
Is SuperMontage voluntary?
PRO:
Yes. A market participant will continue to have a choice of whether to continue sending its best bid and offer to NASDAQ or go to the Chicago Stock Exchange, the Cincinnati Stock Exchange or another market that now or in the future trades NASDAQ stocks. Any competing exchange (including an ECN creating a new exchange) may choose to have its orders consolidated in SuperMontage or opt out of SuperMontage entirely.
CON:
No. The SEC Order Handling Rules and Reg. ATS require that all quotes from market makers and ECNs must go into the NASDAQ quote montage. NASDAQ is then taking these orders and requiring them to be transferred into SuperMontage. Therefore, all quotes from market makers and ECNs must go into SuperMontage.
Is there a concern that SuperMontage will be hindered by technological problems?
PRO:
No. NASDAQ’s current availability is 99.86 percent. Compare that to the availability of any other market or alternative trading system and NASDAQ looks very good. Our rapid expansion, however, has resulted in systems, facilities and forecasts being put to the test. That is why SuperMontage will be built with a completely new multi-parallel computer architecture that will be even more robust and scalable to handle the even larger volumes anticipated in the future.
CON:
Yes. NASDAQ’s past technological history is indication that things may not run so smoothly. Having a single point of failure for the second biggest market in the world should certainly be a concern for the investment community.
What does SuperMontage provide that the existing marketplace does not?
PRO:
The amended SuperMontage will provide market participants and investors with additional transparency beyond the NBBO (national best bid/offer) by breaking down the NASDAQ quote dissemination service Prime Data Feed. The proposed amendments will provide for a greater degree of competition among market participants and choice for investors by allowing them to direct orders by way of SOES preferencing. Investors will benefit from a greater degree of competition among market participant that will produce narrower spreads, increased liquidity display and cheaper transaction costs.
CON:
Reduced competition, government granted monopoly for execution, single point of failure for the NASDAQ market.
Since ECNs account for more than 30 percent of the daily NASDAQ volume, is SuperMontage an attempt for NASDAQ to regain some of that volume?
PRO:
As originally proposed, yes. NASDAQ will now have to compete for business like everyone else. Choice has again replaced the potential monopoly of the original SuperMontage proposal. Most of the problems that existed with the original SuperMontage can be resolved if market participants have the option of “voting with their feet” to opt out of inefficient systems.
CON:
Absolutely.
Do the new routing algorithms adequately provide participants enough choices for sending an order?
PRO:
Yes. Unless a market participant overrides the default with specific instructions, non-directed orders will be executed in price-time priority, without regard to access fees. Additionally, a separate execution algorithm will be established by NASDAQ to address the concerns of market participants who prefer to trade with ECNs that charge access fees — but only after all other potential counter-parties have been exhausted.
CON:
NASDAQ has not stated what the algorithms would be. They have only stated that two of the choices will be to ignore access fees or not. This ignores the other SEC stated possibilities of achieving best execution: speed and size. In addition, these choices are only given to investors placing market orders. Investors placing limit orders are not given any choice but to have their orders potentially discriminated against.
Could we see certain ECNs go out of business because their liquidity is dried up?
PRO:
Consolidation is more like it. This has already started to some degree at the “retail” end of the ECN spectrum with NexTrade being acquired, and Island and Instinet seeking possible merger. There is only so much order flow to go around. ECNs will have to continue to re-invent themselves and continue to provide innovate service and trading tools if they are going to survive. Merely matching trades will not cut it.
CON:
Some might. However, ECNs have proven to be quite an innovative bunch. Presumably, they will innovate to survive. Unfortunately, they may have to do so in new ways while the innovative trading advantages they’ve brought to investors in the past are lost in the new NASDAQ system. |
