In a divided vote, the SEC passed Reg NMS, ushering in a new and improved trade-through rule that will make best price and fast quotations a requirement for U.S. equities trading.
The question the industry has now is, What will become of the Intermarket Trading System (ITS)?
According to Roger Burkhardt, CTO of the New York Stock Exchange, absolutely nothing. While addressing the audience at industry trade show TradeTech on the day that Reg NMS was approved, Burkhardt said, "The plan currently is that the current ITS wires are adequate." He said that ITS will be used but in conjunction with the new fast rules. "ITS has no shortcoming technologically, as everyone has moved to fast IP-based connections," Burkhardt added. Industry sources, however, contend the opposite.
"The old ITS infrastructure is essentially dead," says Sang Lee, managing partner at Aite Group, a research firm. "Everybody agreed this ITS infrastructure was no longer viable to maintain our market structure," he adds. One of the problems with ITS - an electronic communications network that links nine markets, including the New York and American stock exchanges, the regional exchanges, the Archipelago Exchange, the Chicago Board Options Exchange and Nasdaq - is that it doesn't include the electronic communications networks (ECNs), Lee notes.
If exchanges must route orders to other market centers that have a better price, one of the major changes will be the need for exchanges to link with ECNs. "First, you're going to see a step up in the degree of electronic linkages among the different ECNs and exchanges," predicts Brennan Carley, chief strategy officer and chief technology officer at Radianz, a global connectivity provider to the financial industry. "A lot of those private linkages already exist - some are through us and through leased lines," Carley adds.
The new market structure rule was approved on April 6 in a 3-2 vote. Despite opposition from electronic markets, such as The Nasdaq Stock Market, Archipelago and Instinet, and from big institutions, such as Fidelity Investments and Charles Schwab, that wanted the freedom to choose speed and certainty of execution over best price, SEC Chairman William Donaldson, a Republican appointee, pushed through the initiative by voting with the two Democratic SEC commissioners.
"Our objective all along has been to discard the outmoded Intermarket Trading System, or ITS, trade-through rule, which applies only to listed securities and which contains significant loopholes," said Donaldson prior to the vote, noting that the existing rule fails to distinguish between electronic- and human-intermediated quotations. However, rather than scrapping the controversial trade-through rule - which prevents market centers from ignoring best prices displayed on other markets - the Commission expanded the rule to cover Nasdaq-listed securities. But can the industry rely on ITS' technology to support compliance with the rule?
Market centers will need to display an automated quotation that is both electronically accessible and instantaneously executable, or they will risk having their prices ignored by other market centers. "In order for the NYSE and other floor-based systems to be able to do that, they need to increase their automation," says George Rodriguez, managing director at TradeTrek Securities, an institutional broker.
Meanwhile, although Burkhardt contended that the NYSE's hybrid system has been in development for a year and is close to ready, Lee cautions that changing the Direct+ electronic platform will not be a minor adjustment. "This is essentially going to be the core of the exchange and it's incredibly important that they get this right and do it in a timely manner," he says.