A Future For ECN's?
cnnfn.com
NEW YORK (CNNfn) - Electronic communications
networks, which are shaking up how the stock
markets work, are a little shaken up themselves after
a critical report Tuesday. It suggests ECNs, which let
buyers and sellers of stock meet without the use of
middlemen such as market makers and specialists,
will ultimately head the way of the dodo.
ECNs say they're ready to fight for their survival.
They feel they can compete long term with the
established stock markets on the technology front
and on the cost of executing trades. More
immediately, talks are in progress for them both to
pool their operations and to consolidate ownership.
Even if the nine ECNs ultimately are doomed,
their rapid growth will continue over the next two
years, according to Octavio Marenzi, who compiled
the report for Meridien Research Inc. They already
account for around 30 percent of Nasdaq's volume.
Marenzi predicts that will rise to 50 percent of trading
on the Nasdaq stock market sometime in 2001.
"But this is not a long-term template situation,
where they're amassing this liquidity," Marenzi said.
He foresees their eventual extinction over four or five
years. "What's most likely to happen is that Nasdaq
moves to an electronic trading system and really
obliterates the ECNs."
What does the future hold for electronic
communications networks? Executives at the ECNs
themselves admit they don't know for sure. But the
world of these alternative trading systems or
quasi-exchanges is likely to change rapidly in a
relatively short time, and to transform the way stock
markets as we know them operate.
Consolidation the first step
Many observers expect large-scale consolidation
of the nine ECN players, down to two or three. ECNs
have been growing in market share because they
allow big institutions to trade anonymously, meaning
they can shift large blocks of stock without alerting
the market and causing a dramatic shift in price.
Increasingly, brokerages are hooking up to them to
offer after-hours trading to retail customers.
ECNs also offer cheap execution. For instance,
on Island, the second-largest ECN, the average
commission for a 1,000 share block is 75 cents.
That's because they run with very few employees --
Island has 38 -- and rely on computer technology to
match orders. The computers that match orders on
Island are basic Dell PCs.
The ECNs' biggest immediate challenge is their
lack of liquidity, particularly in the extended-hours
trading they offer. They're basically pools of
limit-order trades that sit separate from each other.
People involved in the talks say Instinet, Island,
REDI, Archipelago and B-Trade, the five largest
ECNs, are soon to declare their intention to link up
and pool their after-hours trading.
During the day, if ECNs can't execute orders
internally, they rely on Nasdaq's SelectNet system to
link them with the other ECNs and market makers.
ECNs have set up some links directly to each other,
too.
If the ECNs do hook up, they could set up a
system to compete with Nasdaq's SelectNet both
after hours and during the day. Critics say SelectNet
is expensive, and some ECN insiders think they can
set up a faster system.
The majority of the ECNs are in merger talks
already at a corporate level and "material
discussions" are under way, according to a person
familiar with the talks. A "substantial consolidation"
is likely in the near term, he said.
Markets will become more like ECNs
In response, Nasdaq and the New York Stock
Exchange will become more like ECNs. That's why
Marenzi expects the ECNs to die out. He believes
Nasdaq will become what he calls a "super ECN." It
will evolve into a fully electronic system, with a
central limit-order book.
Eventually he expects Nasdaq to phase out the
market-maker brokerages that, until ECNs surfaced,
carried out all the trades on Nasdaq. ECNs cut out
the market makers -- middleman broker-dealer firms
that make their profits on the spread between the bid
and ask price on the stock, buying it at a slightly
lower price than they sell at. "They're going to be the
real losers in this, and really are already seeing the
pain and the pinch from ECNs," Marenzi said.
The market makers have stayed afloat because
the stock market's volume has also increased while
ECNs have robbed them of trades, he said. But he
and the ECNs envision a market that's entirely
"transparent," where all the participants can see all
the prices, and efficient, where buyers and sellers
link without middlemen. "We're sort of seeing the
death throes of the dealer-driven market," Marenzi
explained.
Market maker traders thrive on inefficiency in the
market, linking buyers and sellers at different prices.
As electronic links get better and the buyer and
seller are able to meet directly, "making money on
the spread will become very difficult to do," he said.
"It's just a bad place to be a middleman anywhere."
To survive, market maker brokerages would
become more speculators than arbitrageurs, he said,
making money from stocks rising or falling rather
than price inequities. Specialists, who perform a
similar function on the New York Stock Exchange,
also are likely to see a substantial change in their
role. The NYSE has seen less impact from ECNs,
but observers expect it to make itself more ECN-like,
more electronic, as well.
Philip Berber, CEO of CyberCorp, an Austin,
Texas-based software company, envisions "one
electronic hub, with no middlemen in the middle,
within which buyer and seller orders will be
electronically matched." His company is in talks with
large Wall Street brokerages and the ECNs to
provide the front-end software and back-end links to
the participants, the "operating platform," on which
that would run.
Exchange status might let them go it alone
Three of the ECNs have filed with the Securities
and Exchange Commission looking to become
independent exchanges. The SEC is unlikely to act
on the requests until next year, after Year 2000
problems pass. How new, for-profit exchanges would
be regulated also is very much up in the air.
But they ultimately could break away from
Nasdaq, which at the moment they operate through
rather than compete with. They also could seek their
own listings, something Archipelago requested in its
SEC filing. If and when ECNs become exchanges,
they would have greater access to New York Stock
Exchange listings.
Even if Nasdaq creates a central limit order pool
and becomes an ECN-like exchange of its own, "you
still need to compete on price, technology and
liquidity," said Jack Vensel, vice president of sales at
Island. Stock markets would become much more
commoditized products, where the cheapest and
fastest computer hookup gets the trade.
Berber, the CyberCorp CEO, sees that happening
first in U.S. equity markets, with Nasdaq, the NYSE,
and the ECNs. But the "electronic hub" he foresees
would expand internationally, becoming global and 24
hours a day. Its scope would grow to incorporate
bonds, futures and options, too.
How long will it take? Not long, he thinks, like
most things computer-related. "What I've just
described to you, the evolution in this space, will
happen --" he paused to think -- "in a little over 18
months." |
