SuperMontage and ADF Ready to Take Flight, But Nasdaq Market Remains Jumbled

Two systems expected to compete for Nasdaq quotes are set for launch, but the likes of Instinet, Island, Archipelago and Tradebook still have key decisions to make.

After years of rule filings, regulatory amendments and delays, SuperMontage and the Alternative Display Facility are finally set to make their long-anticipated Nasdaq debuts. SuperMontage, Nasdaq's $100 million order-display and execution network, will launch on Oct. 14. The ADF, the quote display and trade-printing facility the National Association of Securities Dealers built in compliance with a Securities and Exchange Commission mandate, will essentially go live on the same date - with support from Instinet, the largest electronic-communications network. But, despite the fact that two key systems now have solid start dates, the Nasdaq landscape is still filled with uncertainty.

It remains unclear, for example, which Nasdaq participants - besides Instinet - will post their quotes in the ADF. The SEC actually gave the NASD the green light to launch the ADF, on a pilot basis for Nasdaq stocks, on July 29. But the NASD had no luck recruiting participants for the ADF, and the commission decided to step in to try to help the facility in late August. However, when the SEC asked ECNs to commit to displaying their Nasdaq quotes in the ADF, Instinet was the only ECN to publicly step forward. The rest of the ECN community, citing time constraints and testing concerns, rejected the ADF - a facility that is supposed to provide a viable option to market participants that do not want to display their prices on SuperMontage.

Undoubtedly, Island was the most significant ECN to shun the SEC's ADF invitation. Island's decision was puzzling because, on top of having issues with SuperMontage, the ECN finalized its merger with Instinet - it's one-time rival - on Sept. 20.

The Bloomberg Tradebook ECN, like Island, voted against participating in the ADF, because it needed at least three months to fully connect to the platform - rather than the six weeks the SEC offered the ECN community on Aug. 29. Meanwhile, Archipelago, an ECN that has spent the past year transitioning into a full-fledged stock exchange, is too busy finishing up its merger with the Redibook ECN to link to the ADF by mid-October. Tradebook plans to post all of its Nasdaq quotes on SuperMontage, following the system's expected Oct. 14 launch, and is working towards establishing a link to the ADF by early next year. However, neither Island nor Archipelago is eager to commit to SuperMontage - a network that will compete with ECNs for executions.

Instinet/Island: A House Divided?
Through its commitment to the ADF, Instinet showed its intention to battle SuperMontage, head-to-head, for Nasdaq-transaction supremacy. But it will be extremely difficult for Instinet to compete directly with SuperMontage if it is not on the same page with Island.

Many industry observers believe that Island's subscriber base and technology will provide Instinet with the ingredients it needs to successfully match up with SuperMontage, but the exact venue in which Instinet/Island will post their collective Nasdaq bids and offers remains up in the air.

After it rejected the ADF, Island said it was still unhappy with quote fees tied to SuperMontage, and was consequently investigating quote-display alternatives - including the Cincinnati Stock Exchange. But, with the merger out of the way, will Instinet convince Island to joint the ADF? Or will Island persuade Instinet to abandon the ADF in favor of the CSE?

An Island spokesman declines to comment on the quoting future of the combined entity. But Sang Lee, an analyst covering e-trading at consulting firm Celent Communications, says that Instinet/Island better make a decision on its quoting strategy expeditiously. "While Instinet and Island try to figure out exactly what to do about their combined entity, there's a danger that, within a matter of months, Nasdaq could potentially suck up some of the liquidity that may have been going to Instinet and Island separately. If that happens, the decision (to merge) may come back to haunt them," he says.

However, as long as their integration does not move at a snail's pace, the Instinet/Island team should be in a good position to compete with SuperMontage for order flow. Rick Spear, a managing director at the financial-services consulting firm Oliver Wyman & Co., says that SuperMontage will probably be most attractive to the broker/dealer community - specifically to Nasdaq market makers. Instinet, he says, will probably lose some of its market-maker volume to SuperMontage, but should be able to counter that with volume it gains from Island's subscriber base - which is mainly comprised of direct-access day traders and hedge funds. "In its best-case scenario, SuperMontage will have a tremendous amount of broker/dealer volume, but should not have either the institutional or direct-access volume that Instinet and Island have," says Spear.

Steve Swanson, president and chief executive officer of Automated Trading Desk, says the Instinet/Island entity will be a "formidable" rival to SuperMontage. ATD trades Nasdaq stocks, in support of its own account and on behalf of large institutional clients, through ATD Brokerage Services - its NASD broker/dealer subsidiary. Today, Swanson says, ATD Brokerage Services routes a large portion of its orders to Instinet and Island, and the firm does not expect that to change following the launch of SuperMontage.

Archipelago and Tradebook Weigh Options
Like the Instinet/Island team, Archipelago will have to pick a quoting venue for displaying its Nasdaq prices by Oct. 14. But, in contrast to its ECN competitors, Archipelago will only have to post its quotes on either the ADF or SuperMontage temporarily. Early in 2003, Archipelago expects to migrate all of its Nasdaq business to ArcaEx, the all-electronic stock exchange it launched earlier this year.

Nonetheless, the decision about where to post its quotes on an interim level is a difficult decision for Archipelago, because it would prefer not to give any of its business to SuperMontage, says Archipelago Chief Economist Jamie Selway. "If you play in Nasdaq, even at (only) the best-quote level, you're helping them. You're keeping them relevant and you're supporting them in a way," he says.

Still, despite its distaste for Nasdaq, Archipelago may choose SuperMontage as its temporary-quoting facility - partly because it has not yet completed its integration with Redibook. Archipelago plans to use the matching engine of Redibook - an ECN it merged with earlier this year - to temporarily run its Nasdaq ECN business. But the ECNs are still in the process of transitioning all of the combined stocks they trade to the Redibook matching engine, and Selway says that Archipelago is consequently wary about the time it might take to establish reliable connectivity to the ADF.

That said, since it has its own long-term solution to the quoting dilemma, Archipelago believes it is much better positioned than the rest of the ECN community. "We have a way to show a quote as an exchange. It's massively superior because we don't have to deal with Nasdaq regulators or worry about the costs of Nasdaq technology or overseas adventures that go out of business," says Selway.

One ECN that will post its Nasdaq quotes on SuperMontage, at least initially, is Tradebook. Bloomberg's ECN volunteered to participate in the ADF before the SEC stepped in to try to assist the facility. In fact, in early August, Tradebook was the only ECN that had publicly declared its intention to post Nasdaq stocks on the NASD's facility. But after the SEC asked ECNs to certify their participation in the ADF, Tradebook backed off because it needed more than the six weeks the commission was offering to link to the facility. "The extra six weeks was just not enough," says Tradebook President Kim Bang. "We estimated that it would take us between three and four months to go live on ADF, barring major delays or blowups."

However, Tradebook thinks that ADF prices will eventually be transparent to Nasdaq participants. Bang says the SEC has already ruled that market-data vendors must display ADF prices, in addition to SuperMontage quotes, in their Level II data feeds. With that in mind, he says, Tradebook is continuing to work towards establishing a link to the ADF. In fact, Tradebook expects to be posting Nasdaq quotes in both SuperMontage and the ADF by the first quarter of 2003.

But Celent's Lee cautions that Tradebook shouldn't waste its time. "The ADF is really a non-starter. We still don't see it as a viable alternative to SuperMontage. It's really nothing more than an electronic bulletin board," he says.

An Instinet spokesman retorts that true order-matching ECNs really have no choice but to post their prices in the ADF. "We feel that the alternative to the ADF - staying in Nasdaq - is tantamount to subsidizing a competitor," he says.