Big Board Breakthroughs
Robert Sales, 12/14/2000, WST
Seeking to equip its individual and institutional investor constituencies with increased exchange access and choice, the NYSE is getting geared up to launch a pair of trading services that should add elements of automation and anonymity to its environment.
But whether the services will catch on with their target audience remains an open question. Be honest. When you think of technology innovation, the first words that pop into your mind are not New York Stock Exchange. Indeed, in terms of grabbing technology headlines, the exchange has taken a back seat, in recent years, to its order-driven rival, the Nasdaq Stock Market.
However, the Big Board is working feverishly to create a newer, more automated environment that should change the public's perception of its market. As you probably know by now, the NYSE recently unveiled a $60 million, state-of-the-art trading facility right next store to its old 18 Broad St. floor--which itself has undergone a serious transformation through the deployment of wireless headsets, handheld PCs and other electronic devices. What's more, perhaps more significantly, the exchange is on the verge of launching a pair of services that will offer both individual and institutional investors alternatives to its traditional auction-styled trading.
Faced with new competitive pressures from electronic communications networks (ECNs) and other alternative trading systems, the exchange is getting revved up to roll out Direct+ --an ECN-like matching service primarily aimed at individual investors--and Institutional Xpress--a buy-side-oriented suite of services that should give institutional investors a more efficient venue for executing large block orders and a mechanism for anonymous order execution. Prior to the end of this year, the Big Board plans to go live with Direct+, a service that will equip investors with the power to automatically execute limit orders of 1,099 shares or less. Once launched, Direct+ could bring about a significant change in the way smaller NYSE orders get executed.
In the past, all orders that came into the NYSE through SuperDOT, its electronic trading engine, had to be sent to the specialist post for potential price improvement. But under Direct+, investors, through their NYSE member firms, will essentially be able to bypass the specialist. "It's going to be interesting for the specialist, because their quote's going to change without them doing anything," says Roger Burkhardt, chief technology officer of the NYSE. "When an order gets executed via Direct+, all they [will] see is a trade go up in blue print, outlined in blue in the display book .... There is no human intervention." Before you send a Direct+ order, explains Burkhardt, you must work out an arrangement with your NYSE member firm.
Each individual member firm, he says, will be responsible for providing its client with a Direct+ order-routing option. "It's really up to the member firm and the customer to work that out," says Burkhardt. "All we see is an electronic message coming in, which either has a Direct+ flag on it or not." Direct+, says Burkhardt will offer investors "choice without fragmentation." Via SuperDOT, he says, you'll be able to send an order to a specialist for price improvement or execute a totally electronic Direct+ order. But either way, you will be tapping into a single pool of liquidity.
Every Direct+ order that is routed will get sent to the exact same electronic display book that a specialist is using for a given stock. "We didn't want to fragment the market with separate systems. So all the liquidity for a stock remains in a single system," says Burkhardt. When an order arrives in a display book via SuperDOT, the display book will check to see if it is flagged [by a member firm] as a Direct+ order. If it is recognized as such an order, depending on whether it is a buy or sell order, the book checks to see if it matches up with the best bid or offer for that stock. If a match is found, the order is executed, an electronic fill is sent back to the end customer and the order is then sent along, in real time, to the NYSE's clearing system.
On the other hand, if your order does not match up with the best bid or offer, it will remain on the order book as a limit order. "You don't have to send an order again," says Burkhardt. "If it doesn't immediately interact with the quote, it will just become a standard limit order in the book." Likewise, if you route a Direct+ order for, say, 1,000 shares and you only get filled for 500 shares, then the remainder of your shares will get placed on the book as a limit order.
Due to the maximum size limit of Direct+, the main target audience for the product is individual investors. But Burkhardt says that there are some institutional investors, such as options traders, that will likely have a desire to use Direct+. "A good amount of the [order] flow here comes from options traders who are trying to keep a zero delta. And for them, the ability to very quickly get a hedge on a position may be important ... than getting some price improvement," he says.
Ultimately, a member firm must determine what's more important to its clients: price improvement or speed and certainty. If price improvement is more important, than the member should send a traditional SuperDOT order to the specialist on behalf of its client. But if speed and the certainty of knowing you can execute against the best bid or offer is most important to the member's client, then Direct+ is the more appropriate option. On average, it takes a NYSE specialist approximately 22 seconds to price improve an order.
In contrast, Burkhardt expects a Direct+ order to get executed in "just a few seconds," round-trip. However, pre-decimalization, an NYSE specialist working a market order was able to get a better price than the best bid or offer for a stock one-third of the time--and that percentage is even higher for stocks that have been decimalized. So, both approaches have their pros and cons. "What you don't get in NYSE Direct+, and you do get through a traditional SuperDOT order, is the opportunity for the specialist to tell the crowd--if someone is holding an order in his hand and hasn't revealed it--to step forward. And that's an important capability for the institutional investors, especially when they have big orders," says Burkhardt.
Indeed. Richard Rosenblatt, president and CEO of Richard A. Rosenblatt & Co.--an execution-only institutional brokerage member of the NYSE--says that his firm frequently routes orders through SuperDOT. And frequently, he says, those orders are price improved. "One of the reasons we do our customer's business on the floor is because of the continual opportunity for price improvement," says Rosenblatt. That's extremely important, he says, because "price and liquidity" are all that his clients care about.
However, he concedes that since price and speed are sometimes synonymous, Direct+ may offer occasional benefits to his clients. "Depending on what my client's investment philosophy is ... the stocks they are trying to buy or sell may be stocks that are moving actively in one direction or another. So sometimes speed is exactly what you want," notes Rosenblatt. All things considered, Rosenblatt expects to use Direct+ infrequently, at best. One problem lies in the fact that a typical Rosenblatt customer order is much larger than the 1,099-share limit of Direct+. But the firm may use Direct+, on occasion, to get partial fills for its clients. "We might, for example, have a 15,000 share order, and might want to pick a spot where the market is turning and very quickly access the offer on 1,000 shares ... and then it might be a useful tool."
Institutional Initiatives
While Direct+ is expected to appeal mostly to the individual investor community, the NYSE has also introduced Institutional Xpress--a suite of services aimed at institutions that typically trade larger-sized NYSE orders. Xpress Information--a market data component of Institutional Xpress that streams real-time data to member firms--was launched in June. But the two trading components of Institutional Xpress, which should be of more interest to institutional investors, are not scheduled to be launched until the spring of 2001.
The first trading mechanism NYSE expects to go live with is Xpress Orders, a service which will provide institutional investors with the power to execute large orders without the risk of an order being chopped up into smaller pieces. In order to qualify as an Xpress quote, a quote of 25,000 shares or more must be sitting in a specialist's book for at least 30 seconds. After finding such a quote, an institutional investor, through its member firm, will then be able to route a SuperDOT order to the specialist--and the specialist will then be responsible for filling the investor order for the full 25,000 shares (or more), provided it matches up with the bid or offer being displayed on his book.
Essentially, the goal of Xpress Orders is to give institutional investors a vehicle for getting complete fills when they are routing large block orders. Simply put, if your Xpress Order matches up with the best bid or offer that's been displayed on a specialist's book (for a 30-second minimum), you're going to get filled for the full size of your order--guaranteed. "The specialist will expose [your order] to the crowd, and you might get the 25,000 shares at a better price. But the worst you'll do is get the full 25,000 shares at [the original best bid or offer] that was displayed on the book," says Burkhardt.
After an Xpress Order is sent, it will either get filled or automatically canceled. The fill, of course, happens when your order is the first to match up with an order on the display book. But the order will be canceled immediately if you happen to be second in line. "We could have chosen to put that order on the book as a limit order, but the feedback we got ... from the buy side was, ÔNo, I don't want to show my hand. If I can't get the whole quote, I don't want anyone to know I've even been trying,'" Burkhardt says.
In the future, if an institutional investor wants to route an Xpress Order, it will first have to contact its member firm--either electronically or over the telephone. If they choose the electronic method, they must input the order via their member-firm-supplied order-entry software. The order would then travel to the broker's trading desk, and, subsequently, to the exchange (via SuperDOT). But regardless of which routing option the institutional investor chooses, the member is responsible for flagging that order.
Rosenblatt, the exchange member, says that market conditions will determine whether an institutional investor will derive any benefit from declaring an order an Xpress Order. "Certainly, if an offer that I'm showing a client that he wants to buy is on the book, and he wants to buy it through an automated system, then Institutional Xpress takes some of the risk out of it for him. But if the offer is in the trading crowd, then it offers no advantage at all, because the specialist, in receiving that order, doesn't have to cross the stock. He simply takes the offer and there's no opportunity for anyone to get involved and interact with that trade," he explains.
Matthew Carney, an equity trader at the investment management firm TrustCo, says that his firm typically phones in NYSE orders of 25,000 shares or more to its broker. But since the firm is not overly concerned about getting partial fills, Carney says that he doubts that TrustCo would make use of Xpress Orders on a regular basis. "From our standpoint, what we really care about is [our broker] getting the deal done on their side," he says. "Whether it's all done in one block order or in pieces doesn't affect us that much."
Depending on the success it experiences after it goes live with Xpress Orders in March, the NYSE may adjust its 30-seconds/25,000-share parameters. Those parameters, says Burkhardt, are "not set in stone," because decimalization is gradually bringing about changes at the Big Board and the exchange wants to "be sure that there is a reasonable frequency of these Xpress Quote conditions."
Xpress Routing, an anonymous order-routing tool, is the second trading component of Institutional Xpress. Basically, the tool enables institutional investors to route an order to the NYSE, through SuperDOT, without revealing their identity to the specialist, the member firm or anyone in the trading crowd. However, there is one catch: if investors want to use Xpress Routing, they will have to be sponsored by a member broker/dealer. That stipulation will require an institutional investor to set up pre-arranged credit and order-size parameters with its member firm prior to using Xpress Routing. Burkhardt says that the NYSE decided to build an anonymous order-routing mechanism to accommodate the needs of a group of institutional investors that had expressed a desire to protect the "sensitive information" contained in its order flow.
At the same time, however, it wanted to be very careful not to disintermediate its broker/dealer members. "So, using Xpress Routing, the institutional investor is still sponsored by a member, but a member does not see the order," says Burkhardt. The NYSE created Xpress Routing by working very closely with an advisory group of institutional traders.
But just how popular Xpress Routing will become remains uncertain. Rosenblatt says if institutional investors are concerned that their member broker may be "shopping" their orders, the Xpress Routing may be a very viable option for them. But that's not an issue at Rosenblatt, he says, because the firm always protects the anonymity of its clients. "We never shop orders, so my clients are not concerned about my knowing what they're doing," he says. "If they're interested in executing orders that I'm not aware of, I'm comfortable with that. But, so far, [Xpress Routing] isn't anything that my clients seem to have any interest in at all."
Meanwhile, TrustCo's Carney says that maintaining anonymity throughout the entire process of an NYSE trade is not currently a priority at his firm. "Right now, that's not a large concern of ours--but it might be down the road," he says. But Burkhardt remains confident that, collectively, the exchange's new services will provide benefits for institutional and individual investors alike. The goals of the NYSE, he says, are to provide its clients with "access, choice and an end-to-end electronic market." Out of all its projects, the Big Board is perhaps most proud of its pending launch of Direct+. "This is the first time that an exchange has introduced a hybrid system that has the best of both worlds. It provides the investor with a choice of auto execution or a floor auction [execution]. But it does not require the investor to make the choice of which liquidity pool to go to," says Burkhardt.
Of course, if Direct+ proves wildly successful, there will undoubtedly be whispers that the exchange would be better off if it scrapped its floor in favor of an all-electronic environment. Or, at the very least, that the exchange should extend the capabilities of Direct+ to much larger-sized orders. But with a new, $60 million floor, the former option seems far-fetched. And, due to the price discovery and anonymity inherent in floor-based trading, the former alternative seems almost as unlikely.
"The floor system provides that information, confidentiality and the anonymity/non-disclosure ... that the large orders are looking for," says Burkhardt. "And there's no way that you can interact with that automatically, because it's not in the institutions interests to tell that floor broker, 'oh, sure, show the world what we're trying to do here.' If they wanted to do that, they wouldn't need a floor broker." |
