November 5, 1999
NYSE Considers Electronic System
To Fill Small Trades Automatically
By GREG IP
Staff Reporter of THE WALL STREET JOURNAL
The New York Stock Exchange is considering one its most radical changes in 20 years: a new electronic-trading system for automatically executing small orders.
While responding to the threat of electronic competitors and potentially giving small investors faster, cheaper trades, the exchange's new system would also, for the first time, cut floor traders out of a potentially big share of its business.
Under the proposal, orders under 1,000 shares could be immediately executed at the best price then available on the exchange, rather than joining the "auction" managed by a designated floor trader, known as a specialist.
Big Board Considers Pricing Stocks in Penny Increments (Nov. 4)
"It's a pretty big change: the first time the exchange is routing orders away from the specialist," a person familiar with the proposal said.
Although about 90% of the NYSE's orders are delivered electronically already, over its DOT system, the actual execution of the trades is still done manually.
The proposal is at the preliminary stage, and there is no assurance it will ultimately be adopted. Thursday, Big Board spokesman Richard Adamonis declined to comment. But the fact the exchange is considering such steps shows the competitive pressure it faces.
While embracing automated delivery, the Big Board for decades has resisted demands to automate the execution of orders, arguing an investor's order got the best price through interaction with other investors on the floor. But in recent months it has come under pressure from its largest member brokerage firms to respond to the competitive threat of cheaper, faster trading systems known as electronic-communications networks, or ECNs. Such systems can execute trades in a few seconds, while the Big Board on average takes 22 seconds.
The current proposal, dubbed "fast execution" internally, would in effect create the stock exchange's own ECN for small orders, executing trades in three seconds or less for investors who want it, people familiar with the proposal say. The system would also enable the exchange to easily extend trading hours without fully staffing its floor at night, people briefed on the proposal say. It could also give the Big Board its long-sought platform for trading the competing Nasdaq Stock Market's issues, such as Microsoft Corp. and Intel Corp., although that isn't part of the current discussions.
At the same time, the exchange is attacking its costs by proposing to eliminate specialist commissions on any DOT order executed less than five minutes after arriving at the floor. That is up from the two minutes proposed just two months ago.
Wall Street dealers such as Goldman Sachs Group Inc., Merrill Lynch & Co., Morgan Stanley Dean Witter & Co. and Citigroup Inc.'s Salomon Smith Barney are the Big Board's biggest customers and like to do business there because of its deep pool of orders and regulatory reputation. But those firms also worry about Internet brokers and ECNs eating into their franchises, and want the Big Board to help them respond with faster and cheaper trading. As a hedge, these firms have also invested heavily in trading systems such as Archipelago Holdings LLC and Primex Trading NA LLC, which could one day compete with the stock exchange.
ECN Share Could Change
At present, ECNs have almost no share of Big Board volume, but that could change. Chicago-based Archipelago, for example, which counts Goldman, Merrill and J.P. Morgan & Co. as shareholders, plans to start executing Big Board stock trades in a few weeks (it executes only Nasdaq orders now), and to later register as a full-fledged stock exchange.
This raises the risk that stock trading will fragment among multiple venues, leading to chaotic and unfair pricing -- especially with next year's switch to decimal prices.
To prevent that, the Securities and Exchange Commission has begun a concerted campaign to sweep aside some of the regulatory barriers to integrating electronic-trading systems with the traditional markets. SEC chairman Arthur Levitt has proposed the Big Board put its orders into a central book along with those of all other markets, including ECNs.
The Big Board began automating the delivery of orders in the 1970s with its DOT system (now called SuperDOT), and today about 90% of orders representing about half of its volume travel over SuperDOT. But all orders, upon arriving at the floor, must still be executed manually by a specialist, after floor brokers have had a chance to bid on the order. (The exception is "odd lots": Orders of fewer than 100 shares are automatically executed.) Sometimes the investor gets a better price as a result; for example, when a broker pays him $100.125 for his shares when the highest bid at the time was $100.
Under the current proposal, investors who chose "fast execution" would lose the chance for price improvement.
Disenfranchising Floor Brokers
The proposal in effect disenfranchises floor brokers and specialists from a sizable part of their business. But those so far briefed on the proposal have been surprisingly supportive, people familiar with the situation say.
Orders of fewer than 2,100 shares account for 80% of the Big Board's transactions but just 23% of its total volume. (Data for orders of 1,000 or fewer shares are not available.) Floor brokers generally don't handle such small orders, and specialists have lost a lot of that business to nonmember dealers and regional exchanges and soon could lose more to ECNs. By offering, in effect, its own ECN, the exchange might win some of that business back or at least prevent further loss.
Even if the floor is not happy about the proposal, the threat of electronic competition might quell any opposition. There is also the hope it would spur more trading, expanding the business for everyone.
The proposal is relatively new. An informal group made up of the heads of Goldman, Merrill, Morgan Stanley and Salomon have been urging Big Board Chairman and Chief Executive Richard Grasso to move more to electronic trading, and in an interview a month ago Mr. Grasso acknowledged their concerns: "They want faster, cheaper, more-frictionless executions, and we are looking at all sorts of combinations of technology to be able to provide that kind of service, consistent with our model."
Mr. Grasso and two of his top lieutenants, Robert Britz, who is in charge of market data and technology, and Catherine Kinney, who is in charge of new listings and client services, broached the proposal last week with several floor members.
Still, it isn't clear whether the proposal will go far enough to satisfy Wall Street firms, which almost every month invest in a new system meant to address some perceived shortcoming of the floor.
Just last week, a group of big investment dealers, including Morgan Stanley, Warburg Dillon Read LLC, and Lehman Brothers Holdings Inc. announced it would build a new trading system called Nyfix Millennium, which would skim from the orders that dealers send to the floor any that can be matched internally among the consortium partners. The system would run on wires already maintained by Nyfix Inc. which connect the dealers to the floor.
Write to Greg Ip at gregory.ip@wsj.com |
