Nasdaq OMX's Third Exchange: Are There Too Many?

In the ongoing liquidity wars between exchanges and alternative trading venues, Nasdaq OMX went live with a new trading platform last Friday to attract large orders that would normally go to dark pools.

In this CNBC video interview, Nasdaq EVP Transaction Services Eric Noll explained what the global exchange operator, Nasdaq OMX, is trying to accomplish: “What we’re trying to here is attract more liquidity back to the listed markets and the transparent markets. So obviously as you know, the price time markets as they work today have done a tremendous job of getting a narrowing the bid-asked spread, but one of the things they haven’t done so well is build thickness of liquidity in a transparent way on the marketplace. And that’s what this model purports to do.” While the Nasdaq OMX PSX will offer a Reg NMS-protected quote, meaning it will only trade when it has the best price at the top-of-book, Noll said it will allocate the trade differently than the prevailing price-time priority markets. “The next measure of how you will allocate a trade on the bid-offer spread will not be the time your arrived at that bid-offer spread, but the size of your quote that is transparent and visible in the marketplace,” Noll explained.

The idea of bringing large institutional orders back to the displayed markets, appealed to CNBC reporter Bob Pisani.“We need to get (institutions) with size orders to come to the market,” adding they had been picked off and pushed out.”

But Pisani raised the question of whether this will help retail investors find liquidity. Noll said the new model would help since the average trade size both on dark pools and lit markets is sub-300 shares, though some order sizes are a little above. (And some are way above: Liquidnet’s average trade size is 50,000 shares). But the average retail transaction size can be 800 or 900 (shares) on an order. “If we can thicken our bid-offer spread here and provide real liquidity this will also meet some of the needs of the retail investor,” contended Noll.

Perhaps more interesting than how the new trading platform works, is the controversial question of whether we have too many stock exchanges and ATSs. Noting that we’ve got 12 exchanges, and 40 other alternative trading venues, Pisani asked, “Are there too many exchanges out there? Should the SEC move to limit the number of exchanges? “Obviously we have to be worried about fragmentation and preserving the reliability and the structure of our marketplace,” said Noll. I think the SEC worries about this (market structure) and thinks about how that should change, post May 6th,” he said. While there have been industry calls for a “moratorium" on approvals of new market centers or dark pools due to fragmentation and complexity from Themis Trading and others, exchanges which have liquidity on multiple platforms and can afford to experiment with different maker-or-taker rebate/fee incentives, usually maintain that their platforms bring innovation and competition. “I think in this particular case, the innovation we’ve been able to bring to the marketplace here outweighs whatever I would consider to be the fragmentation risks,” said Noll.