Decimalization Creeps up In the Homestretch

Yes, a new era is dawning on Wall Street, but before anyone can sit back and reap the rewards, the industry must address the obstacles that lie ahead.

While decimalization may have been overshadowed by the now all-too-familiar and hopefully distant Y2k bug, the industry-mandated change from fractions to decimals is fast approaching. Ready or not, the decimal-conversion issues continue to creep into the IT agenda as securities firms contemplate how much volume will increase and will the systems be ready for the compounding capacity?

In contrast to Y2k compliance, where firms will see within days whether or not systems are functioning properly, the conversion to decimal pricing will play out as a compounding growth of price points, trades and quotes, says Andy Mayer, managing director at Arc Partners, a consulting firm specializing in technology and business services for the financial community.

Decimalization is expected to hit the Street with phase one of the implementation scheduled to begin July 3, 2000. The first step will convert 30 to 40 pre-selected securities to trade at a minimum price variation (MPV) of a nickel or $.05. This move from 16 price points, where equities and options currently trade, to 20 price points is expected to have major implications, which will only increase as the MPV eventually could reach one penny and 100 price points. These changes will result in increased transaction volume with decimalization forcing participants in the equities and options markets to beef up their systems and prepare for greater capacity and communication abilities.

"Effectively, there are a few reasons why the increases will occur," says Scott Abbey, chairman of the Securities Industry Association's Decimal Steering Committee and CIO of PaineWebber Inc. "There are more prices at which you could do a trade, therefore people will tend to take advantage of that and if the MPV decreases by a substantial amount we believe that some participants are likely to do more, smaller trades than today."

Abbey says that in addition to required changes to code for applications to handle decimal pricing, firms also "need more computers, more servers, more routers, more wide-area network points, etc." in order to accommodate the anticipated rise in volumes. A study conducted by the SIA last May estimated that the volume of quote messages per second (MPS) on the New York Stock Exchange could increase 50% in the year 2001 if securities were quoted in nickels and over 200% if quotes were in pennies. The SIA study took into account the June 1997 change in price variance from 1/8 to 1/16.

Mayer agrees that firms should be ready for significant increases in volume and should consider several aspects when addressing capacity control. "The pipeline is one component where perhaps you have to go from a T+1 to a T+3," notes Mayer. "More important are critical intersection points within the infrastructure. For example, do you have breakpoints in your throughput that cannot handle the volume of additional quotes and additional related information surrounding the quotes? You could have a cumulative effect that could kind of sneak up on you if you're not prepared for it."

Craig Plotkin, senior manager of Arc Partners, adds that volume increases will also lead to narrowing margins and overall operational risk could be jeopardized as firms struggle to keep up. "As margins start to be reduced there could be more pressure to change processes, to upgrade systems quickly to allow for handling the capacity and, before you know it, you're starting to push your operational risk issues without even knowing it," says Plotkin.

"If a firm underestimates the increase in volume, either for equities or options, their back office could start to really slow down," warns Plotkin. "Whether it's because the infrastructure or the operations staff can't handle that extra capacity, things slow down and it could be that a firm won't be able to complete all the trades that it agrees to make."

Firms should be concentrating on middleware capacity in addition to accommodating greater transactions and keeping an eye on operational risk. "As you have an increasing amount of information there are two concerns," explains Mayer. "One-can the middleware actually pass it through quickly enough to get all the information in the analytics systems? And two-can the analytics systems handle that type of volume?"

Phase two of the decimal implementation is expected to begin August 7, when all securities would be traded in nickel MPV. The SIA Decimalization Committee will be overseeing the industry performance at each stage and will evaluate the implementation to determine when and whether to continue to phase three. If all goes according to the plan, the decimal conversion is expected to be complete in October of 2000 when all securities will be trading with unrestricted MPV.

So as the strain of Y2k begins to fade and technology efforts get redirected, decimalization is next up on the plate. While the SIA is hoping that the switch to decimals will make the markets more understandable for investors and compatible with the rest of the world, industry watchers warn against underestimating the effects of narrowing margins and increasing volumes.