Newsmaker Interview with Gerald Putnam, Chief Executive Officer, Archipelago
Securities Traders Assoc.
1. ECN's such as Archipelago have grabbed an increasing share of the market in recent years, igniting a debate on the role of ECNs vs. that of traditional market-making firms. Can ECNs and market makers co-exist?
Without question. In fact, the market maker-ECN relationship is symbiotic. As an ECN, Archipelago receives a great deal of liquidity from market makers, which choose our system for its speed, low cost, and anonymity. We've always thought of ECNs as a natural place for market makers to liquefy the positions that they take in the course of committing risk capital to facilitate execution for clients.
As an Exchange, Archipelago will further solidify our market maker relationships. In addition to the traditional services we've provided to our dealer clients, we are adding direct role for market makers in our exchange, through a competing market maker model. Market makers will have the ability to interact with directed order flow in both Nasdaq and listed stocks, provided that they meet price improvement criteria. Marketable orders will seamlessly pass through the price improvement layer based on parameters established in advance by the market maker.
In addition, we plan to pay market makers for liquidity provision, and the cost to code to our systems will be minimal. This stands in stark contrast to the development costs borne by Nasdaq dealers over recent years, as they are forced to commit resources to accommodate a never-ending barrage of system changes.
2. In March, Archipelago and the Pacific Exchange announced plans to create the first fully electronic national stock exchange for NYSE, Amex and Nasdaq stocks. How are the plans progressing? When can we expect a launch? What benefits will this exchange offer to investors?
The Exchange has moved through the publication of its rule filing and the public comment period. We continue to work with the SEC and are hopeful that we will be approved within a month or two.
Investors will benefit from our exchange because at its heart, it is an open order book organized by strict price-time priority-something investors, particularly institutions, have requested for some time now. We will also continue to provide intelligent order routing in the name of "best execution," both through traditional links, such as SelectNet and ITS, and our own high-speed lines to frequent trading partners, such as other ECNs.
We're excited about the ability of our exchange to validate best execution for market makers via our price improvement algorithm. We're also hopeful that our automated opening auctions, which will occur at 8 AM and 9:30 AM ET, will help price discovery, particularly in the OTC marketplace. I don't think we're the first to suggest that the Nasdaq opening, or lack thereof, needs a little work. Arthur Levitt envisioned a pre-opening price discovery system. Clients have asked for it.
3. Nasdaq continues to advocate SuperMontage as the one central order display that can serve the industry and investors' needs and contends it has addressed issues raised by ECNs that have opposed it. How do you feel about SuperMontage? Are there alternatives you prefer?
We fought hard for what we thought was a fair resolution to the great Super Montage debate. We weren't trying to limit the strategic decisions that Nasdaq could make, we were simply saying that if Nasdaq wanted to evolve towards an execution venue, it would have to parse out its regulation business and exclusive information collection business. Our position was that if this didn't occur, a Nasdaq execution venue would enjoy an unlevel playing field, which would reduce choice and consequently harm investors.
As it turned out, others agreed that Nasdaq needed to make some changes, and finally even Nasdaq agreed that separation was best. Before Super Montage is implemented, NASD will effectively spin off its residual interest in Nasdaq. Moreover, the execution venues will work together to create a successor to Nasdaq as information collector for OTC securities. Archipelago and PCX are playing an active role in that process, and we're hopeful that the industry can create an effective means for UTP exchanges, ECNs, and market makers to display trading interest to the marketplace. In other words, a true alternative to SuperMontage.
In terms of Nasdaq's business model going forward, whether its SuperMontage, Optimark, Primex, or SuperSOES, we believe that we can compete favorably in terms of technology and client service. And although we probably won't choose to use SuperMontage ourselves, Nasdaq certainly has a right to build it, and should do so if it thinks it creates value for market participants. Throughout this process, all we were looking for was the ability to keep doing what we do.
4. Many industry insiders have noted that ECNs enjoy all the benefits of exchanges with little of the regulation. Many advocate a leveling of the playing field, subjecting ECNs to the same regulation as exchanges. How would you respond?
Well, Archipelago is a bit of a counterexample to that line of thinking, given that we're actually opting for a higher degree of regulation. As a facility of the Pacific Exchange, PCX will function as our SRO to ensure that our system and its participants meet the high regulatory hurdles of an exchange. In addition, our exchange will have a fully electronic surveillance system in place. This system will monitor trading activity using sophisticated, electronic reporting tools to ensure its integrity and fairness.
We've chosen to "graduate" from ECN to exchange because we think there's tremendous value to exchange cachet, a great deal of which is due to heightened regulatory status. Clients know what the term "exchange" means. In Europe, in particular, clients aren't familiar with ECNs. By providing a trustworthy, well-regulated marketplace, we create a great deal of value for our clients.
5. New rules by the SEC require brokers and market centers, including ECNs, to disclose information about the quality of the trades they execute. According to the SEC, this information will enable investors to make more informed decisions regarding the actual cost of their trades beyond just commissions or fees per trade. Will this affect the way Archipelago or other ECNs do business?
More disclosure to investors is almost always a good idea, and we believe that this is certainly the case as it relates to execution quality. In terms of our business, we view these SEC rules as a substantial opportunity, as opposed to a regulatory burden or dead-weight cost to doing business in the industry.
If you consider that one of the primary findings of the SEC execution quality study was that OTC trading costs are essentially equal to listed trading costs for the top OTC names, you can begin to understand how ECNs reduce trading costs. ECNs are at the inside market over 75% of the time in the top shelf OTC names-the marketplace is almost entirely order-driven, except for really big blocks. Our view is that the SEC's analysis validated what our clients have known for years: ECNs are an effective way to minimize trading costs. We expect that disclosure will provide further evidence of these benefits.
6. ECNs were among the first to jump into after-hours trading, despite the major market centers' decisions to hold off extending their trading sessions. To date, volume in the after-hours market has been thin, liquidity has been low and most the trading occurs in the hour or so after the markets close. What lies ahead for after-hours trading?
The growth of volume during extended hours has been slow and steady, but it's still an illiquid market best left to professionals. Until there is a central venue that displays the last sale and best bid and offer from all systems that trade during extended hours, investors will continue to feel uneasy about how their orders are executed.
We offer after-hours trading because it's easy and cheap for us to do so-our computers don't get tired if they have to stay on for an extra 4 or 5 hours. While we still view after-hours trading as an interesting possibility, we're more interested in pre-opening trading, particularly for European clients. In that regard, we hope that our exchange's two opening auctions will be helpful price discovery vehicles for trading before the opening bell.
7. Archipelago is the only ECN that is using the Nasdaq InterMarket link. Has that been successful, and what has it done for your customers?
We've been very pleased with our integration into Nasdaq Intermarket, which allows our clients to display listed orders directly in the National Market System. By virtue of this display, our quote is disseminated to other exchanges and vendors, and is made accessible via the Intermarket Trading System. We offer the same innovative order types and smart routing for listed names as we do on the OTC side.
We're currently very excited about our listed business. To us, it feels a little bit like the first few months after the Order Handling Rules were implemented in January 1997-we're teaching our clients about the services we can provide, doing a lot of listening and learning, and trying each day to improve our business.
Although we're still small, clients are happy with two aspects of our listed offering thus far. The first is the ability to trade exchange-traded funds, or ETFs, in a fast, anonymous, low-cost fashion. These products are about as order-driven as they come, and a number of our clients have begun to "make markets" via limit orders posted in our book. On a given day, we'll be at the inside more than half the time in the largest ETFs, and we often are more than 5% of the tape in some of the smaller products.
The second element is decimalization. Not that I have anything against specialists, but it appears from the early returns that a pretty profitable business just got that much better. Our clients are finding that a listed ECN provides them with a means to effectively compete with the floor. On Archipelago, if you cancel an order you get a fast out, and no one on our system gets a 15- or 30-second break to decide if they should step ahead of you by a penny to intercept the right kind of market order flow. It's just a cleaner model in which everyone knows the ground rules. |
