Is SuperMontage's Honeymoon Over?

While it's still early in the SuperMontage world, firms trading Nasdaq stocks say that things are running smoothly and many continue to rely on ECNs to help them get best execution. So it's basically business as usual.

However, if there's a stumbling block it's that there are still locked markets - not just within SuperMontage itself, but across the whole of Nasdaq, as the liquidity pie remains fragmented across different pools.

Jay Suskind, director of trading at Ryan, Beck & Co., a regional broker/dealer in Livingston, N.J., says that while there might not be locked markets within SuperMontage, because some ECNs are not participating in it, there are still locked markets "many times" throughout the day.

A locked market is when the bid and ask price are the same and the unlinked markets make it difficult to execute. "It becomes physically impossible to hit the bid when markets are locked. From a technical standpoint, it's difficult to execute," Suskind explains.

Although the NASD has rules designed to prevent it, users say locked and crossed markets - where the bid exceeds the offer and there's no execution - still happen.

"Fragmentation of the liquidity is still the issue," says Hedi Reynolds, managing director for Nasdaq trading at Morgan, Keegan, Inc., a broker/dealer in Memphis, Tenn.

"SuperMontage itself is working great," she says. The "problem" is that there are too many other sources that traders have to track; including the Alternative-Display Facility, the Cincinnati Stock Exchange (where Island posts its information) and ArcaEx. "Investors look at them without having to trade with you." But that's a "market structure" issue that the Securities and Exchange Commission is examining, she notes.

When it comes to firms that trade Nasdaq stocks, the impact of SuperMontage, and its effect on ECNs, depends on the type of firm you are, says Rob Hegarty, vice president of securities and investments at the TowerGroup in Needham, Mass.

"If you are a market maker, in that sense (SuperMontage) is a good thing. It's bringing together markets and allowing you to view the market and execute against it. If you are a buy-side institution, it remains to be seen what the benefits are," says Hegarty.

Damon Kovelsky, an analyst at Meridien Research adds that SuperMontage means "more choices" for firms trading Nasdaq stocks. It's important that investment firms have a "look at each" liquidity pool and "have access in some way or another" to all of them, he says.

In addition to such connectivity, firms must ensure that they are deploying the right filters to help them sort the data and display it on a single screen. As well, he says, smart-order-routing technologies - with both internal and external capabilities - will also be important moving forward.

Here's how some users view SuperMontage.

Bernard L. Madoff Investment Securities, LLC
For Andrew Madoff, head of Nasdaq trading at Bernard L. Madoff Investment Securities LLC in New York, SuperMontage is a welcome addition.

"We are reflecting several levels of interest in SuperMontage, which we were unable to do in the SuperSoes environment. I'm trying to use it whenever I can," says Madoff.

The problem with ECNs, says Madoff, is that they've been taking credit for market share that doesn't belong to them and SuperMontage will change that.

"I'm seeing that I am able to retain attribution for my own volume in a way that ECNs don't allow me to. When I put volume in an ECN, they take credit for that as their trade and it's not their trade, it's my trade. The ECNs over the years have sort of co-opted the credit for that volume and I think that's over."

Now, he says, "When I put that order in SuperMontage, it's a Madoff trade. It's a big factor and something I've heard a lot of market-maker firms say that they care about, because there's all this talk about ECN market share. Market makers are accounting for a portion of that volume. That's not ECN market share, that's market-maker share, and the way that market makers will win back the credit for that trading volume is by putting that into SuperMontage."

Firms won't immediately abandon ECNs, he says, but, "I see the increase in the use of SuperMontage by market makers. It will be continuous but at an evolutionary pace."

"I think the biggest impediment is that big firms have their systems programmed to use ECNs in certain situations and those changes can't be made overnight. Even a firm that decides strategically they would rather keep the volume in SuperMontage, there's a lot of work that needs to get done to facilitate that change."

Will firms abandon ECNs? "Not completely," he says. "I think there are certain situations where use of an ECN is warranted. ECNs still provide a level of anonymity that SuperMontage doesn't provide. There are still a couple of order types that SuperMontage doesn't support that various ECNs do," such as pegging and discretionary orders. "That's really it. There's not a huge list."

American Century Investments
For John Wheeler, senior equity-trading manager for American Century Investments in Kansas City, Mo., it's business as usual and SuperMontage's arrival has changed little in the way the firm conducts its 7 million trades a day.

"To be honest with you, we haven't really noticed much of a change. If you think about it, it's the same liquidity, the same buyers and sellers and the same stocks we had in the pre-SuperMontage environment."

Wheeler says his firm uses Archipelago and Bloomberg Tradebook and, "Both of those ECNs have many, many high-speed connections to other pools of liquidity. So our traders on our desks didn't really notice much of a change whatsoever, because the pools of liquidity that were out there are still out there."

What SuperMontage does, Wheeler says, is "display that liquidity in a more user-friendly format and allow more of that liquidity to be accessed in an auto-executed environment. The speed and reliability has been solid."

Any change you might notice, he says, is related to operations. For example, when interfacing to SuperMontage through an ECN, "If you notice anything, it may be a little quicker execution as your incoming order accesses that liquidity." He says that's because SuperMontage "took so long from inception to launch that many ECNs created their own SuperMontage-like environment around various pools of liquidity."

Wheeler thinks that ECNs will continue to do well despite SuperMontage, noting that some of the data coming out of Nasdaq suggests an uptake in overall trading volumes for some ECNs.

"They provide low-cost, anonymous executions for the institutional community and those have been our sticking points all along. ECNs have established themselves as reliable providers of anonymous electronic execution and I think that's only going to continue."

He adds that while the big broker/dealers are all in the SuperMontage environment, it's not always in their interest to trade there. "If I am a market maker at Goldman Sachs and I am trying to buy stock for a customer, do I really want to buy it from my prime competitors in a SuperMontage environment? Or do I perhaps want to go to a venue that might access the ultimate end provider and step outside SuperMontage if I can get that volume done? I fill my customer orders, while I am leaving my competitors orders hanging. That's not a huge factor but certainly part of it."

TD Newcrest
When it comes to SuperMontage, "We view it as a positive thing, bringing together providers of liquidity to ensure best execution for our clients," says Ray Tucker, managing director of institutional equities at Toronto-based TD Newcrest, the institutional equity arm of TD Securities.

Tucker says, "The way we view it is (SuperMontage) is basically Nasdaq catching up to where the Canadian marketplace has been the last five years or so."

He says it's "still early in the game. The system is just ramping up as we speak. The early indications have been positive from the Canadian perspective," says Tucker, whose firm has "access to pretty much all the major U.S. ECNs."

Before SuperMontage, he says, "We were basically pulling together liquidity. This makes our job easier." Having more liquidity is a good thing, he says, and it will "encourage investors" to trade.

When it comes to ECNs and what services they need to attract his business, Tucker is non-committal. Post-trade anonymity - something SuperMontage doesn't offer - is foreign to Tucker. "We don't have post-trade anonymity in Canada. We're used to our numbers being on the tape post-trade."

However, he says, it boils down to service. "I think at the end of the day, the marketplace has to provide value to investors and clients. Those ECNs that provide value are going to succeed and those that don't, won't," he says.

Ryan, Beck & Co.
For Ryan, Beck & Co.'s Suskind, SuperMontage "has been less of a noticeable change than one would have expected. It's been a non-event."

"It was a lot more software engineering and things like that behind the scenes from a programming standpoint that took place, as opposed to what the trader actually sees and does. I didn't see that big of (an impact) on the tactical way of trading."

Suskind's biggest beef is that, because some of the ECNs haven't joined SuperMontage, it's led to crossed and locked markets across the liquidity pools. "If you look at the most actively traded stocks, it's locked many, many times a day. It used to be a violation to lock or cross a market, but it's happening frequently. I've seen the market locked for four, five, six or seven minutes. It's not just for two-and-a-half seconds."

But he thinks some of these kinks will work themselves out. "Every time the Nasdaq marketplace changes its structure, it takes a few weeks or months for everybody to kind of get their bearings and figure out how it's going to actually work."

"I'm sure you will see a lot of ECNs, from their own profit standpoint, determine what they need to do. This business is one of proacting and reacting. I think what you will see now is a lot of reacting to how this system works and how an ECN or broker/dealer needs to operate in this environment to be profitable."

Suskind says he uses ECNs. "Whether you like them or dislike them, they are part of the landscape and you basically have to at least have access to them." As such, he says, ECNs will survive.

The bottom line, he says, is that it "becomes a margin and cost decision" to use ECNs. "Sure, ECNs do provide a service, but it's really a question of the cost. I think the biggest thing the broker/dealers had issue with ECNs from the onset, is that we have to pay to access an ECN. It doesn't cost me anything to trade with another broker/dealer. I think that has obviously been a huge bone of contention."

Victory Capital Management
The arrival of SuperMontage hasn't been a big deal for Brian Pears, head of equity trading at Cleveland-based Victory Capital Management Inc, a domestic money manager with $62 billion in assets.

"If anything, we've probably gone a little bit more to ECNs than we did in the past," he says, noting that "We were relatively heavy ECN users anyway. So I am not sure it's really changed what we do."

"We're mainly an Instinet user right now," he says, but the firm recently got Archipelago on its desktops as well.

Pears says that the "entire landscape is changing. The only thing we're trying to be cognizant of is that we may not be able to get access to regular market makers through our ECN the way we used to before, so it's something we have to be careful of."

However, he says, because of the type of stocks Victory trades, it usually finds enough liquidity on the ECNs it uses so that, "We don't worry too much about it. We can usually find all the liquidity we need."

He, too, says it "bothers me an awful lot" that you can get crossed or locked trades across the Nasdaq market as a whole. Before, the main problem was within SuperSoes or within Nasdaq itself. Now, the way that Nasdaq stocks are being traded, it's the "overall structure that can cause a locked or crossed market."

Though the firm is largely an Instinet user, Pears says he has also used Bloomberg Tradebook in the past. The firm is also "looking very seriously at getting Lava in here."

LavaColor Book, from N.Y.-based Lava Trading Inc., consolidates market-data information from all the ECNs and exchanges into a single, high-speed data feed. Traders can submit orders through Lava's unified order-execution interface or other systems.

Pears adds, "It gives us access to anything calling itself an ECN with as much functionality as any of the ECNs have, which is obviously the whole game. It's really important to have the flexibility to approach a trade through a variety of different strategies."