More new that's not good for tniy little weak ASTN:"ECNs Look to New Links for Liquidity Electronic trading is taking yet another turn.
Once independent, electronic order-matching companies
are now moving toward links with brokerages and
institutions to get the one thing that will keep them afloat
amid increasing competition and possible regulatory
changes: liquidity.
One of the newest electronic trading firms, Island, and the
oldest, Instinet, each moved last week to increase the
traffic coming into their electronic communication networks,
or ECNs.
The fact that these two firms already top the list for
transaction volume among the nine ECNs only indicates
the need for alliances with brokerage firms, exchanges or
other institutions to protect or grow their businesses
through captive order flow, analysts say. They're hoping
their new partners keep their relationship -- and investment
-- in mind when they are directing retail trades.
"In order for [ECNs] to survive, they need order flow. By
establishing agreements, they are basically guaranteeing
themselves a source," says Greg Smith, an analyst at
investment bank Putnam Lovell de Guardiola & Smith,
which hasn't done any underwriting for any of the firms
mentioned in this story.
Waterhouse Securities, an online and discount brokerage
owned by Toronto-Dominion Bank (TD:NYSE), agreed
Tuesday to buy a 12.5% stake in Island, a unit of Datek
Online Holdings. That move, Island President Matt
Andresen says, will enable the ECN to "take a few giant
steps forward."
Island's news followed a recent announcement from Instinet
-- a unit of Reuters (RTRSY:Nasdaq ADR) that has long
catered to institutional customers -- that it is talking to both
online brokerages and traditional brokerages about moving
into the retail realm. Investment bank Goldman Sachs
(GS:NYSE) and online brokerage E*Trade (EGRP:Nasdaq)
found themselves unlikely bedfellows as partners in Terra
Nova Trading's Archipelago ECN.
All-Tech Investment Group, a Montvale, N.J.-based
daytrading firm that offers the Attain trading system, is
talking to different parties, including a large mutual fund
complex, about a strategic partnership that could include a
stake sale, according to All-Tech Chief Executive Harvey
Houtkin.
And Datek Online President Ed Nicoll says, "a firm like
Island could partner with a lot of different firms and
institutions."
Amid this climate, Island is taking a path that is likely to
guarantee revenue. Island will use part of Waterhouse's $25
million investment to apply with the SEC for exchange
status. That could lead ECNs to generate the kind of big
money that exchanges do by charging for the transmission
of real-time equity quotes and other data.
Such developments may seem far removed from investors
trading shares of Yahoo! (YHOO:Nasdaq) or Amazon.com
(AMZN:Nasdaq) over the Internet, but it's those investors
who so far have enabled ECNs to ambush the
establishment.
Online investors send their orders via the Internet to their
brokerage. A company like E*Trade or Ameritrade
(AMTD:Nasdaq) will then either send that order to a
Nasdaq market maker or to an ECN.
In addition to the quest for order flow, though, link-ups
between brokerages and institutions are also happening
because of changes ahead in the Nasdaq stock market,
analysts and industry executives say.
Primary among those changes is the handling of limit
orders -- orders in which the customer asks to buy or sell
at a set price -- and a key volume factor for the ECNs.
With pressure from regulators concerned about unknowing
customers getting caught up in volatile markets, online
brokerages are advising their clients to place limit orders
when possible, making the ECN a more likely destination.
Bernie Madoff, head of wholesale firm Bernard L. Madoff
Investment, says that about 50% of order flow is now in
limit orders. Market makers do handle such orders, but
they are less profitable. And market makers don't pay
brokerages for limit orders as they do for market orders
(so-called payment for order flow).
Most stocks that online investors trade actively are listed
on Nasdaq and quotes are disseminated between market
makers and ECNs. With the millions of orders being
handled in so many different places, there has been
pressure to allow customers to see more information about
other existing orders. The SEC is currently considering two
proposals: One creates a central order file for limit orders
(called the central order book) and the other enables
market makers to list market orders and limit orders
separately.
If the central limit order book is approved, it would
essentially duplicate the function of ECNs, Putnam Lovell's
Smith says. "There is no need for nine different ECNs. The
ideal marketplace is one single order book," he says.
Whether such a book will be created soon is unclear. In
addition to SEC approval, such an idea needs Nasdaq
member support. Madoff, who heads the Securities
Industry Association trading committee, says that the
proposal, which failed when it was first brought up last year,
won't do any better this time around. The agency quote
proposal does enough to improve transparency, he says.
"The industry basically feels that the NASD shouldn't be
building a central limit order book that would compete with
its membership, which all have their own order books,"
Madoff says.
Lon Gorman, president of Schwab Capital Markets &
Trading and a member of both the SIA board and Nasdaq's
influential Quality of Markets Committee, agrees that the
agency quote plan may win over the central limit order
book. It has both the institutional and retail support needed
to be accepted, he says.
That proposal, in fact, could also put a dent in the ECNs'
limit order business because market makers could create
competing pools of limit orders. "The agency line is a
mechanism to take your limit orders out of your quote," he
says. "Instead of sending them to an ECN, you create your
own ECN."
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