Island, the largest electronic-communications network in the United States, has historically matched 100 percent of its customer orders internally. But the ECN's business model will change, and it will, for the first time, route orders outside the Island network if it decides to list its Nasdaq quotes on SuperMontage, the Nasdaq Stock Market's $100 million order-routing and execution network.
Around one month ago, Island announced that it would join SuperMontage, rather than list its Nasdaq quotes on an alternative-display facility (ADF) being built by the National Association of Securities Dealers. However, in early May, Island began having second thoughts about listing on SuperMontage, after Nasdaq announced a plan that increases regulatory fees for its most active market participants.
Still, despite its displeasure about the regulatory fees, Island remains very interested in participating in Nasdaq's next-generation network, which is scheduled for a July 29 launch. In fact, Island has already completed most of the development on a so-called SuperMontage Switch, which will allow Island subscribers to route Nasdaq orders to SuperMontage if no internal match can be found within the ECN.
Sending outbound traffic to SuperMontage would represent a significant philosophical change for Island, which has historically shunned order routing. Indeed, Island chief technology officer William Sterling says that the ECN has been very hesitant to enter into the order-routing community, because of fees tied to certain ECNs and "the difficulty" of delivering "good routing" in the existing marketplace. But Island decided to tweak its philosophy with SuperMontage, because it decided that having an outbound interface to the network would be in the best-execution interests of its subscribers.
"There is a lot of pent-up demand for order routing. Our sales force and our key subscribers for a long time have been asking for us to develop a product like this, and a few weeks ago we made the decision to make sure that we would have an (order-routing) product ready for our subscribers on day one of SuperMontage," says Sterling. "It's tough for us to say how much additional volume this is really going to give us ... (but) the response we're getting to this (order-routing switch) is great."
The interface to SuperMontage, he says, should position Island as a "one-stop shop" for customer orders, rather than just an execution destination. The ECN plans to offer an Island-only option for subscribers who don't want any of their orders routed outside of Island's matching engine. But subscribers will have a choice, if Island decides to participate in SuperMontage. "As a new and additional service, we're going to offer an interface to (SuperMontage) to subscribers. In that scenario, if a customer sends us an order that is non-marketable, meaning that there is not a match either on Island or according to the quote on SuperMontage, we would just post it on our book and then display it. But if you entered a marketable order, we'll scan it against the Island book and see if we can view an immediate match, without incurring the costs and the latencies of SuperMontage. And then if we don't find an immediate match, then we'll route that order on to SuperMontage for execution," Sterling explains.
Island currently has no plans to offer direct-order-routing interfaces to any other ECNs. Sterling says that Island has the interfaces "in place" to directly route orders to its competitors, and could quickly go live with links to rival ECNs, if there were valid reasons to do so in the future. However, for now, Island is content with its plan to route orders to a single outbound destination. "On day one (of SuperMontage), we think the optimal order-routing algorithm for us is going to be to scan Island and, if we find not match, to route that order to SuperMontage," says Sterling.
Of course, whether Island actually routes outbound orders to SuperMontage is contingent upon its participation in the network. And at this stage, there is no guarantee that the ECN is going to post its quotes on Nasdaq's network. An Island spokesperson says the ECN is still weighing its options about where to post its Nasdaq quotes. The ECN, he says, is particularly upset about Nasdaq's decision to significantly increase regulatory fees for its most active market participants. "We think this (new fee structure) is aimed at trying to inflict the regulatory costs upon ECNs, and Island in particular .... So we want to have as many options open as possible," says the spokesperson.
At press time, Island was exploring other "options" that could significantly alter the Nasdaq/SuperMontage landscape. Sources say that Island is currently holding merger discussions with rival Instinet Corp., which owns and operates the second-largest ECN. Today, Island and Instinet collectively account for roughly 22 percent of the market share in Nasdaq stocks, and, if they were to join forces, the pair of ECNs would certainly have great leverage to compete head-to-head against SuperMontage - regardless of where they decided to post their combined Nasdaq quotes.
But one source familiar with the ECN landscape says that Island is also weighing one other alternative: a merger with Archipelago, the former ECN that was transitioned into a self-regulated stock exchange earlier this year. Archipelago, which also recently completed its merger with Redibook, a rival ECN, has already begun trading listed stocks on its exchange. Moreover, by the end of this year, Archipelago and Redibook plan to post all of their combined Nasdaq quotes on the Archipelago Exchange. That move, says the source, will eradicate the need for Arca/Redi to post their Nasdaq quotes on SuperMontage.
Consequently, he says, if Island were to merge with Archipelago, it would have no need to post its quotes on Nasdaq's network. "Maybe that's also why Island is reassessing whether to join SuperMontage. They could end up merging with the Archipelago Exchange, which will not be a long-term participant in SuperMontage," says the source.