Wet dream indeed, Mr Walker. Hmmm, ASTN as usual is missing:
"Wall Street Revolution Technology is toppling trading's Berlin Wall
(if you get the angle Mr. Walker, you see that ASTN is toast)
By Bill Alpert
Since the first trickle of electronic trading in 1969, seers have forecast the
toppling of the world's mightiest stock exchanges. "It's like the fall of
communism," says Doug Atkin, chief executive of Reuters Group's electronic
network Instinet. "You got so numb hearing about it that people decided it
would never happen. Then you turned on the TV and the Berlin Wall was
coming down. And in 30 days, it was all over."
The cracks are now too wide to ignore. Wednesday, three sources of
enormous trading order flow -- Donaldson Lufkin & Jenrette, Fidelity
Investments and Charles Schwab -- threw their weight behind an electronic
trading system called Redibook. The creator of that so-called electronic
communications network, or ECN, is none other than a card-carrying
member of the old guard, Spear Leeds & Kellogg, a Nasdaq market maker
and the largest specialist on the New York Stock Exchange. This new group
should drive the share of Nasdaq volume that flows through ECNs
substantially higher than its present 30%.
Like party apparatchiks
flying their loot to Cyprus,
many other New York
Stock Exchange member
firms are upping their bets
on electronic alternatives.
Merrill Lynch, Morgan
Stanley Dean Witter and
J.P. Morgan have each
invested tens of millions of
dollars in electronic
upstarts, such as OptiMark
Technologies, Archipelago
Holdings and BRUT. And
the newly public Goldman
Sachs Group plunked
down an astounding $531 million this month for the Hull Group, a Chicago
firm that pioneered derivatives trading in the all-electronic exchanges of
Europe and Asia.
Also entering the fray are Wall Street outsiders like Japan's Softbank, which
recently announced plans to invest $75 million in OptiMark, a Jersey City,
New Jersey, electronic trading system that has received $150 million of
funding from the likes of Goldman and American Century Companies.
The response of the powers that be has so far been measured in half-steps.
But lately the NYSE has been talking about creating a network for trading
Nasdaq stocks off the exchange. And on July 29, the governing board of the
National Association of Securities Dealers (NASD) will meet to consider the
startup of a super-ECN of its own. And both organizations are contemplating
initial public offerings.
Too little, too late? Listen to Benn Steil, an economist who studies stock
markets at the Council on Foreign Relations in New York. "All natural
economic distinctions between stock exchanges and broker-dealers have
broken down," he says. "Exchanges and brokers are now doing exactly the
same thing." In the near future, Steil expects America's big stock markets to
follow the lead of the Stockholm and Sydney exchanges, where the silent
screen has replaced the open outcry.
Behind this shake-up on Wall Street lie regulatory forces and technology. As
part of its settlement of a 1996 antitrust investigation into collusion among
market makers, the NASD issued new rules to govern how market makers
handle customers' limit orders (orders to buy or sell stock at a specified price,
as opposed to market orders -- orders to buy or sell at whatever price the
market makers set when the transactions take place).
What this means is that limit orders, which in some cases offer better prices
than those posted by market makers, became visible to buyers and sellers.
That's where ECNs come in. In an instant, these networks can match buy
orders with any corresponding sell orders. The benefit to investors? Market
makers pocket the spread between the bid and ask prices for a stock -- that
can range between five cents and 75 cents. When an ECN processes trades,
it charges a fee of a couple of cents per share.
The oldest and largest electronic network is Instinet, which began serving
institutional investors long before the NASD reforms. Officially registered as a
broker-dealer, Instinet has enabled its big-money clients to trade over 170
million shares a day in 40 of the world's markets, as well as after the close of
the U.S. exchanges. Though Instinet accounted for just 16% of Reuters' $2.5
billion in revenues for the six months ended June, it produced 28% of Reuters'
profits and grew 23% over the prior year stretch.
Over the past three years, nine new ECNs have sprung up, offering a variety
of innovations. Datek Online's Island ECN, for example, promotes
transparency by allowing online retail investors to see each other's orders.
Eclipse Trading, based in New York, plans to let individual investors trade the
stocks of the Standard & Poor's 100 Index and the Nasdaq 100 Index, in an
after-hours session from 6 p.m. to 8 p.m. Eastern time. And the BRASS
Utility, or BRUT, which is majority owned by NYSE-listed SunGard Data
Systems, has a direct line into 3,000 traders' terminals in 175 brokerage firms.
Table: In the Vanguard. . .Or In the Way?
For investors looking for more than just efficient trading, the closest thing to a
pure-play ECN stock is the Investment Technology Group. Publicly traded
since 1994, ITG was controlled by Jefferies & Co. until it was spun off to
shareholders this past April. ITG's POSIT network crosses institutional
investors' orders anonymously, at the midpoint of the spread between the bid
and ask prices in the stock's main market. This low-cost matching procedure
has endeared ITG to quantitative investors, who must have rock-bottom
transaction costs for their strategies to work. ITG crossings have grown 60%
annually over the past decade, to reach almost six billion shares in 1998. That
earned the firm $43 million, or $1.41 per share, on 1998 revenues of $212
million.
But shares in the New York City firm have slumped over the past month,
from $48 to $33 recently, as growth in POSIT volume slowed abruptly to
around a 7% annual rate. The firm hopes to boost volume when it links its
network with Bloomberg LLP's Tradebook network.
Some of the trading volume missed by ITG may be going to Chicago's
Archipelago Holdings. Created from scratch in 1996, Archipelago finds the
best price for a customer by matching with other Archipelago subscribers or
by reaching out to market makers and such other ECNs as Tradebook,
Instinet and Island.
"Our model is everywhere at the same time," says Archipelago founder
Gerald D. Putnam. "We're pools of liquidity brought together."
Archipelago has staying power. A confidential document obtained by
Barron's shows that just last month, J.P. Morgan & Co. paid $33.3 million for
a 20% stake in the firm. That valued the company at $166 million, up from
just $102 million in January. Goldman Sachs and E*Trade earlier put up $10
million and $25 million, respectively, for what are now roughly 20% stakes.
Filings with the U.S. Small Business Administration, which were included in
the confidential package, show that total historic revenues for Archipelago,
through yearend 1998, were just over $5.5 million. With the order flow from
its heavyweight investors, however, trading volume is climbing. The network
processed 375 million shares in April of '99, up from 170 million shares in
December '98. Gerry Putnam won't comment on the documents. But he does
say that there's no indication that Archipelago's growth is slowing.
For any trading network, electronic or floor-based, volume is the key to
success. A network of traders with lots of orders and capital is an easier
place in which to trade. In fact, this liquidity is what really counts. Indeed, the
curious fact that the world's largest exchanges -- New York, Nasdaq,
London and Tokyo -- are behind the electronic trading curve reflects the
exceptional liquidity that those established marts offer, says economist Steil.
Think of a trading network (or stock exchange) as a phone system. The value
of the network to each participant increases as the number of participants
grows. Challenging an entrenched stock exchange is only possible if the new
entrant can build liquidity at much lower cost. Increasingly cheap computing
power and telecommunications bandwidth are what allow trading networks to
challenge trading floors.
Likewise, anonymity, which ECNs deliver, allows institutional investors to sell
large blocks of a stock without fear that buyers will vanish as word leaks out
that the smart money is selling. Leaks can happen when using brokers, market
makers and specialist firms. Studies by SEI Investments contend that the
largest transaction cost is not the commission or a market-maker's spread, but
this "market impact" as other traders move market prices in reaction to block
trades.
Gripes about the old-boy network have found a voice in Harold Bradley, the
outspoken senior V.P. at American Century, which is 45% owned by J.P.
Morgan. American Century manages more than $90 billion and sends a
substantial volume of trades through such alternative systems as Archipelago,
OptiMark and Tradepoint. "Just last month on the New York Stock
Exchange," says Bradley, "a specialist missed one of our
electronically-delivered orders because he was too busy.
"How can you expect a specialist to out-think and out-react a 500 megahertz
computer chip?" asks Bradley.
But even at 500 megahertz, challenging the big boys is hardly a cinch.
Consider Tradepoint Financial Networks. In May, a consortium of Instinet,
Warburg Dillon Read, Morgan Stanley, American Century, J.P. Morgan and
Archipelago paid about $21 million to rescue the floundering London-based
electronic exchange, which lost $11.5 million in the fiscal year ended March
'99, on revenue of just $1 million. Tradepoint's network for anonymous
matching of limit orders for London-listed issues achieved less than 1% of the
London Stock Exchange's volume.
Tradepoint's new 54% shareholders bring plenty of liquidity, accounting for
about a quarter of the LSE's volume, between them. The rescue revived
Tradepoint shares, which themselves trade on the Vancouver exchange, and
boosted the firm's stock market value from $50 million to a recent $300
million. Tradepoint is now a credible rival to the LSE, which plans to link with
seven other European bourses to trade Europe's top 300 stocks. Tradepoint
expects to offer its own trading in Europe's top 300 stocks within a year. And
in March, the SEC allowed Tradepoint to offer trading of London shares here
in the U.S., through Bloomberg terminals.
One brainteaser is how all this affects Knight/Trimark Group, the Jersey City
firm that has quickly grown into Nasdaq's largest market maker by processing
the trades of online brokers. While shares of e-brokers like E*Trade and
AmeriTrade change hands at frightening triple-digit multiples, the stock of
solidly profitable Knight/Trimark have an earnings multiple of just 30, which
might seem stingy in light of the firm's 300% annual growth rate.
So why have Knight/Trimark's shares slid 10% in the last week, to around
49? In reporting June quarter sales growth of 35% over March '99, on
Wednesday, Knight warned that such quarter-over-quarter growth might
slow to 5%-10%.
Four million Knight/Trimark shares have been sold short -- a chunk equaling
25 times the stock's average daily trading volume. The doubters say that
competition from ECNs will narrow the profits of the Street's traditional
middlemen like Knight/Trimark. But with electronic order handling, trading
volumes will soar, even if order-handling margins shrink. Instinet CEO Doug
Atkin says that should enable efficient market makers to grow their total
profits as the pie grows.
While Knight/Trimark chief executive Kenneth D. Pasternak acknowledges
the challenge posed by ECNs and potentially Nasdaq itself, he says that
losing business in the 50 Nasdaq largest stocks would hardly be terminal.
"The top 50 are not unimportant to us, but they are the least profitable part of
our business," he says. The vast majority of Nasdaq issues, he adds, are thinly
traded and will never trade efficiently without market makers who use their
own capital to keep the ball rolling.
Other members of the old guard, however, may not be so lucky. Just as the
abandonment of fixed commissions on Wall Street a generation ago opened
the door for the discount brokers and slammed it on firms that were slow to
adapt, so too will the move to electronic trading create new winners and
losers."
As usual, there's no mention of Auric's fav, ASTN. Sell the pig!
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