High-tech systems jolt old markets into action
By John Labate
FT.com site; Jun 06, 2002
None of the many issues facing US stock and options markets this year can compare with what the community of traders, dealers, and the exchanges themselves faced last September.
The attacks on the World Trade Center closed US markets for nearly a week and the scale of lives lost will reverberate for years to come. They appear, however, to have left the markets in no worse structural shape, although certain plans have been altered as a result, especially by the New York Stock Exchange.
It was also last year that US markets converted to decimal trading, an event that did leave a deep market structure impact. Decimalisation came as retail trading was already in the throws of a deep downturn. Trading spreads collapsed as a result, making for even tougher times than many had predicted. Now, with trading volumes lower, profits thinner and a dearth of new listings, US traders are looking into a murky future.
Nasdaq, the number two US stock market, is several weeks away from launching its new high-powered trading system, SuperMontage. The system could prove to be its saviour or its undoing. US options exchanges, meanwhile, are bracing for a mandated linkage plan that will only intensify competition between the five rival exchanges. Large automated trading platforms known as electronic communications networks (ECNs) continue to weigh up the pros and cons of merging with each other.
These are huge bets on technology that may eventually alter the balance among leading US market centres. Liquidity tends to follow liquidity and what traders want is faster and less expensive access to buyers and sellers on the other side.
Critics have long charged that the move towards more technology based trading has not come fast enough, but considering the size of trading that occurs every day, US markets are adapting to new electronic technologies in real, if not overly fast, ways. The floor based trading model, as practised at the New York Stock Exchange, the American Stock Exchange and the Chicago Board Options Exchange, shows little sign of ending in the near future, but each has spent millions to upgrade systems and provide more electronic access to their floors.
Most of the dramatic changes, however, have come from small, profit-oriented ECNs. For years these ECNs, including Island and Instinet, have nibbled at the edges of the main US markets, but now they are drawing enough liquidity to be considered real threats to the more traditional markets, particularly Nasdaq.
When a gang of fairly new entrants to a market turn heads with their services and attract sizeable liquidity, the bigger markets are forced to adapt. In a nutshell, that is exactly what is happening at Nasdaq as it tries to head off the assaults of the ECNs.
The result is a patchwork of trading venues in the US. The ECNs have not targeted the NYSE, but when they do it may be forced to speed up the changes while, presumably, keeping its core structure centred around its trading floor.
In spite of the many changes behind the scenes, there are real efficiency issues with US trading still to be addressed. "I'm surprised how much change there has been, but are we getting appreciably closer to where we want to go? I question it," said Robert Schwartz, finance professor at Baruch College in New York. "There are major problems in the handling of institutional order flow and until that's resolved we're not going to have a high quality market for the broader spectrum of participants, including retail."
Traders often complain of the difficulty in processing large stock trades of 100,000-share orders or more. The situation has worsened since last year's conversion to decimal trading in the US, since average order size has become even smaller in response.
To avoid having their large orders direct the price of a stock, institutions are often forced to break down large blocks into many small orders, especially for less liquid stocks, that can take days to make their way through the market. The only other choice is shopping a large trade with other institutions in the upstairs or "third" market, a move that risks exposing details of a trade to other institutions.
Some believe the way large institutional stock orders are broken up and traded can create its own negative momentum. Word of a large number of small trades coming to market often leaks out, causing others to take a position and overeact since they don't know when the many small trades of the stock will end.
The result can be that prices are taken to unrealistic levels, since once the momentum starts it is difficult to stop. Ironically, it is often small investors who stand to lose most from such arrangements. Large institutional trades caught in this large-block bind include those who trade for pension and mutual funds and pools made up of investments of retail investors who may not get the best price for their trades.
One company looking to provide a solution to (and make money from) the problem is Liquidnet, a private electronic platform. Launched early last year, Liquidnet offers its services to buy-side firms looking anonymously to find other parties to trade large blocks of shares without intermediaries or information leaks.
If more institutions use such outside-the-market technologies, dislocations caused by large orders could be reduced. It remains to be seen how strong a following Liquidnet has and whether it will have the impact its supporters suggest.
If Liquidnet is not the solution, others will surely give it a try. As the ECNs proved, outsiders can still have a big impact on the structure of US trading. |
