Competition for ISLD:
Article in NY Times:
nytimes.com
<<Fidelity Joins With Schwab in Electronic
Stock Trading
By EDWARD WYATT
EW YORK -- Fidelity Investments and Charles Schwab Corp.
have been fierce competitors in virtually every business in which
they operate -- mutual funds, stock brokerage, online trading. But on
Wednesday they said they were joining forces.
Fidelity, which is a unit of FMR Corp., Schwab and two other large Wall
Street firms, Donaldson Lufkin & Jenrette and Spear, Leeds & Kellogg,
said they planned to form an electronic stock-trading network.
The venture, which has yet to be named, could quickly become one of
the best-funded and most efficient of the nine computerized stock trading
posts known as ECNs, or electronic communications networks. As such,
it will probably provide stiff competition for the biggest ECNs: Instinet,
which is a unit of Reuters Group PLC, and Island from Datek Online
Holdings Corp., as well as for the NASDAQ stock market itself.
Fidelity, Schwab, Donaldson, Lufkin and Spear, Leeds are expected to
funnel many of their customers' orders to the new operation for
execution, a behind-the-scenes move that should create little noticeable
change for existing customers. But the new venture will probably also
provide a platform from which the partners can offer after-hours trading
to individuals, much in the way Instinet now serves institutions like
pension plans and mutual funds.
Terms of the deal, which participants said was subject to approval by the
Securities and Exchange Commission, were not disclosed. The four
parties will each own a quarter of the new company.
ECNs are relatively new inhabitants of Wall Street, the result of changes
in the way customer orders to trade NASDAQ stocks are handled by
brokerage firms. Those changes, which were instituted in the wake of
federal antitrust scrutiny of NASDAQ market dealers, provided for a
new forum where buyers and sellers could trade stocks without paying a
markup to the professional traders who have long served as middlemen
in the NASDAQ market.
The new ECN will be, in essence, a renovated version of the Redibook
ECN now operated by Spear, Leeds, which is the largest specialist on
the floor of the New York Stock Exchange and makes markets in
NASDAQ stocks.
Each of the four partners will have a financial incentive to make sure there
is sufficient trading on the system to make it a viable alternative to the
NASDAQ system. In order for customers to get good prices for their
orders, the system needs a heavy volume. The new partners already use
ECNs for a significant part of their customer orders, particularly limit
orders, which are requests by customers to trade stocks within certain
boundary prices.
The firms will not be required to send their limit orders to the new ECN
-- on the contrary, they are required by federal securities laws to seek
out the best prices for their customers. But a big portion of small
investors' orders, as well as some orders from the mutual funds
businesses of Fidelity and Schwab, are expected to find their way to the
new market.
Limit orders offer less opportunity for market makers like Spear, Leeds
and Schwab's Mayer & Schweitzer unit to make a profit on a trade.
Securities regulations require market makers to either route limit orders
to ECNs or to reflect those low-margin orders in their current trading
quotes.
But the customers whose orders are sent to an ECN benefit only if a
sufficient number of other investors are there seeking to trade. If not,
orders are less likely to be filled at a desirable price. By joining together
and shuttling a certain portion of their orders to their own ECN, "we are
creating a liquidity pool that we feel will be one of the deepest liquidity
pools out there," said Robert Mazzarella, president of Fidelity Brokerage
Services.
The venture joins three of the largest online brokerage firms in Schwab,
Fidelity and Donaldson, Lufkin's DLJ Direct; three of the biggest
providers of clearing, or back-office processing of securities trades, in
Spear, Leeds, Fidelity and Pershing, also an affiliate of Donaldson; and
four of the biggest NASDAQ market makers.
"We were some of the last holdouts that had not bought a piece or
connected to an ECN," said Lon Gorman, president of Schwab Capital
Markets and Trading. "We each have enough order flow to become our
own ECN, and collectively we present a huge opportunity to get a lot of
orders interacting."
Competing firms voiced little concern Wednesday about potential
competition from the new venture.
"Without a doubt it changes the competitive landscape, and they certainly
are going to come after our business," said Matthew Andresen, president
of Island. "But we're happy to compete with them on the basis of price,
service and liquidity. And I think an entrant of this type is a particularly
strong validation of the power of this model."
Officials of Instinet, which has said it is considering opening up its
electronic trading service to individual investors, declined to comment on
the announcement. NASDAQ officials were not available for comment.
Unlike the big Wall Street firms that own parts of most competing ECNs,
three of the four members of the new venture, excluding Spear, Leeds,
count individual investors as their primary customer base.
That means that a firm like Schwab can use the network as a platform for
providing new services, like after-hours trading, previously available only
to institutions. Schwab officials have voiced dismay over the delays by
the major exchanges in moving to extended hours. The New York Stock
Exchange and NASDAQ have said that they will wait until at least next
year to extend trading, and a study group brought together by the SEC is
examining how an extended session would work.
"We believe this platform offers the best opportunity to offer after-hours
trading," said Gorman. "I don't think we're trying to put a time or a place
on how that is going to work. But after-hours trading is going to proceed
with or without the exchanges, and we're prepared to compete in that."
The new ECN also offers other opportunities to the participants. With far
more transaction volume than Spear's Redibook had by itself, the venture
is a more attractive potential partner for the New York Stock Exchange,
which has said it is looking at a link with one ECN or more. Gary
Goldring, a senior managing director of Spear, Leeds, which is the largest
specialist on the floor of the New York exchange, said that Redibook
had talked with the Big Board about a possible link.
With nine ECNs now operating or in the planning stages, questions have
arisen about how many of them can survive in the long term.
Peter Cohan, a managing director at Donaldson, Lufkin, said the new
venture represented a step toward consolidation in that business, because
each of the partners were heavy users of ECNs, which get paid a small
fee for executing each transaction. Now with their own network, "we've
taken this from being an expense to a way of lowering our expenses as
the markets get more competitive," he said.>>
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