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Trading Technology

02:51 PM
Robert Sales
Robert Sales
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ECNs, Demutualization and Alliances Dominate Electronic Trading Landscape

ECNs have forced the NYSE and NASD to seriously consider re-inventing themselves.

In the realm of electronic trading this year, no firm, or group of firms, has had as much of an impact on the financial markets as electronic communications networks (ECNs). These equity trade-matching systems, through alliances they have formed with both online discount brokerage firms and traditional Wall Street broker/dealers, have forced both the New York Stock Exchange and Nasdaq-parent the National Association of Securities Dealers (NASD) to seriously consider re-inventing themselves.

Over the course of the year, the likes of Goldman Sachs, Merrill Lynch and Morgan Stanley Dean Witter boosted the liquidity of these networks by purchasing minority stakes in multiple ECNs. Moreover, since the NYSE's Rule 390 essentially prevents NYSE members from sending order flow to ECNs, the networks have, indirectly, fueled loud cries for the abolition of the long-standing rule (WS&T, 12/99). The cries were heard loud and clear, as on December 2nd, the NYSE Board voted to rescind it. The repeal will go to the SEC for approval.

ECNs also made the primary markets stand up and take notice by plunging head first into the after-hours equity-trading arena. In an attempt to generate after-hours liquidity, ECNs like Instinet and Redibook signed interface agreements with online discount brokers such as E*Trade and Charles Schwab. Moreover, to further enhance their post-market liquidity, a large contingent of ECNs signed letters of intent in late 1999 to link their respective order books after hours (WS&T, 12/99).

The NYSE and NASD, cognizant of the threat posed by these networks, had partnership talks with ECNs this spring. More recently, at least partly in an attempt to stem the ECN tide, the NYSE and NASD declared their intention to seriously evaluate demutualization (WS&T, 10/99). If they were to adopt that business strategy, the exchanges would convert from member-owned, privately held entities to for-profit, shareholder-based corporations.

Of course, the demutualization trend has not been limited to the U.S. equity markets. The London International Financial Futures and Options Exchange (Liffe) has converted its members' seats into shares, and the London Stock Exchange's board has approved a for-profit conversion plan. What's more, the Chicago Mercantile Exchange's board recently gave the nod to its own demutualization strategy, and the Chicago Board of Trade and the New York Mercantile Exchange are both pondering for-profit migrations.

Sometime in between their demutualization talks, the CBOT and the CME-the two largest futures markets in the U.S.-formed strategic partnerships with Eurex and Liffe-the two biggest derivatives exchanges in Europe. After evaluating technology link-ups with the CME and Liffe, the CBOT agreed to ally with the all-electronic Eurex this summer (WS&T, 8/99). That deal, most significantly, calls for the CBOT to phase out its incumbent Project A electronic-trading platform in favor of Eurex's trading engine by next July.

Meanwhile, the CME/Liffe deal, announced just a short time after CBOT/Eurex, stipulates that the exchanges will build an interface between their respective electronic trading platforms-Globex2 and Liffe Connect.

Not surprisingly, the electronic revolution also made a big impact in the European equities market.

Europe in 1999 saw the birth of E-Crossnet, a crossing network that is targeted exclusively at institutional investors who trade European stocks (WS&T, 10/99). The network-which is jointly owned and operated by Barclays Global Investors and Merrill Lynch Mercury Asset Management-has already signed up 19 large buy-side participants.

So what do all these trends in electronic trading portend for 2000? No one knows for sure. But keep an eye out for an automated bond-trading boom, ECN consolidation and another series of exchange alliances.

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