Trading Without NYSE Specialists
Leslie Wines, 10.07.03, 4:59 PM ET
NEW YORK - Who would benefit if the New York Stock Exchange actually succumbs to mounting pressure to banish entirely its floor specialists and execute only electronic trades? In the wake of allegations of improper trading by some specialists, the NYSE is staunchly maintaining its stance that it is not contemplating an end to floor auctions. But market participants like Jefferies & Co. equities strategist Art Hogan say that it is quite possible, although an orderly transition will require a bit of time.
If the specialists are made redundant, the biggest initial benefits would go to the electronic communication networks (ECNs) and other electronic platforms that are clamoring to increase their share of trades of NYSE-listed stocks, according to Damon Kovelsky, a financial technology consultant with Financial Insights in Framingham, Mass. This group of likely early beneficiaries includes Reuters (nasdaq: RTRSY - news - people ) unit Instinet, SunGuard's (nyse: SDS - news - people ) eBrut, Ameritrade (nasdaq: AMTD - news - people ), Bloomberg, Archipelago and AraEx.
Also likely to benefit are blue-chip hardware makers such as IBM (nyse: IBM - news - people ) and Hewlett-Packard (nyse: HPQ - news - people ) that might get tapped by the exchange and brokerages to build additional electronic infrastructure. Both are regular suppliers to top brokerages. An NYSE spokesman said that the exchange uses a combination of listed and non-listed companies for its electronic needs, but that it prefers to tap listed companies.
The major European exchanges favor software from OM and Royal Blue, while U.S. institutions often develop their systems in-house. Nasdaq developed most of the hardware and software for its SuperMontage system.
In Kovelsky's view, if the NYSE were to end floor trades, one very likely result is that the exchange would at first lose volume to the ECNs, which have low overheads and could underbid the exchange on transaction fees. The NYSE now executes about 80% of the trades of its listed stocks.
Currently, Instinet is spearheading a drive to get rid of the self-regulatory organization rule that gives the NYSE floor specialists 30 seconds to decide whether they wish to execute trades of NYSE stocks generated by the ECNs. Not only does the rule give the specialists a right of first refusal on ECN trades, it also slows down transaction times for the ECNs, which typically makes thousands of trades in a second. Kovelsky says that getting rid of the rule would give the ECNs a chance to dramatically boost their trading volumes, while tossing out the specialists would allow the electronic providers to boost transactions flows that much more.
But Kovelsky says it is far from clear that the formidable Big Board would lose its hegemony if it lost its right of first refusal on ECN trades and also became exclusively electronic. It too might find ways to cut fees and speed up transactions. "The NYSE is known to get very active when it feels threatened," Kovelsky says. "It can be very aggressive and very unpredictable. I am sure it would fight back."
The NYSE spokesman said the exchange remains committed to its combination of electronic systems and the specialist auctioneers who in theory create better prices for both buyers and sellers through verbal negotiations. He pointed out that the NYSE, which already has invested $2.5 billion in electronic technology, currently is executing about 1.4 billion trades a day, and 99% of its transactions are electronic.
But Chris Concannon, a Nasdaq executive vice president of corporate strategy, says the problem with the NYSE system is that the benefits of humanly matched pricing flow unevenly to wealthy retail investors. "It's the large orders that are handled by floor brokers," he says. "They access privileged information for the large orders. But the small orders are handled electronically."
According to Jefferies' Hogan, there is an intriguing possibility that the specialist firms could embrace, rather than fight, a transition to all electronic trading, which he says could take place only after an alternate system is firmly in place. Beset with a somewhat limp market this year and under the glare of harsher regulatory and investor scrutiny, these firms lately have not had an easy time of it or enjoyed heavy profits.
Specialist LaBranche & Co. (nyse: LAB - news - people ) last week cut its quarterly earnings estimate to reflect a rather dull summer market and investor distrust in the wake of the NYSE's probe of its specialists. Fellow specialist firm Spear, Leeds & Kellogg, a unit of Goldman Sachs (nyse: GS - news - people ), has been hurt by allegations that former NYSE Chairman Dick Grasso may have improperly influenced its trading of American International Group (nyse: AIG - news - people ) shares.
"The problem is not that the specialists are being regulated away," Hogan said, "but their profitability could be regulated away. But these firms could decide to run the additional technology themselves. I think they would not sit back and let something happen to themselves. It's more likely they would make the investments and just run the technology themselves." |
