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Cristina McEachern
Cristina McEachern
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ECNs Mull Linking Order Books to Bolster After-hours Liquidity

ECNs are grappling with the best ways to boost liquidity, minimize volatility and at the same time, retain their competitive edge.

As after-hours trading becomes a reality, ECNs are grappling with the best ways to boost liquidity, minimize volatility and at the same time, retain their competitive edge.

Swirling around the excitement of extending trading hours is concern over liquidity issues, which could lead to a volatile market place. ECNs have been trying to figure out how to revolutionize the trading day, while still creating a safe and profitable trading environment for investors. Recently, a consortium of ECNs has come up with a solution-linking their order books after hours.

Bloomberg's TradeBook, Archipelago, Datek Online Holding Corp.'s Island and Spear, Leeds & Kellogg's REDIBook are in discussions to link their share books during after-hours sessions, according to industry officials. Strike is also said to be involved in the discussions, according to an official with Strike. By linking order books after hours, ECN officials believe they will achieve the desired liquidity needed during the proposed pre- and post-market sessions, to make after-hours trading a success.

Although no contracts have been signed, Bloomberg, Archipelago, Island and REDIBook have confirmed that there is a letter of intent circulating among the participants to open their books. Through the sharing of bids and offers during these times, the ECNs expect to create a higher level of liquidity, avoid Nasdaq SelectNet fees and provide more successful trade executions for their subscribers. ECNs and the after-hours market are dependent on liquidity to generate a larger number of bids and offers at the best prices possible. This liquid environment is the way ECNs seek to best serve their clients in an after-hours environment when prices may not be as stable.

The exact details of the pricing structure and time frame of the agreement are still being determined. "As of right now, the busiest times for trading are immediately after the market opens and right before the market closes," says Meridien Research e-financial services analyst Sang Lee. "So I think after-hours trading will initially see adequate liquidity in the two hours before and two hours after market hours." Lee also explains that this isn't the only step the ECNs could be making toward linking and sharing books, "In the near future we do see the smaller players trying to merge with one another to try and get more liquidity into their systems." He adds that this sort of consolidation is an attempt for the smaller systems to compete with the volume of larger ECNs such as Island and Instinet.

"By combining our best bids and offers, we will mimic the national market's consolidated quotes feed among ourselves," says Kim Bang, principal and business manager for TradeBook. "Therefore, anyone can trade through any one of the ECNs in the consortium and be assured the best execution possible." The liquidity that such an agreement would provide is a driving force in the decision to share books. According to Bang, "It's mutually beneficial because everyone will get to share in the liquidity and it's also an obligation to try and provide the best execution possible to the clients." The majority of the eight other SEC recognized ECNs, share Bang's viewpoint that linkages for after-hours trading would benefit each of the involved parties.

Archipelago's director of marketing, Sydnie Kampschroeder, confirms that the ECN is involved in the discussions to link after hours, adding that "the specifics have not been nailed down as far as connectivity, but we have seen the letter of intent that is circulating." She explains that the linkage being discussed would be a series of bilateral arrangements in which each ECN would be linked to another, instead of all linked together, in order to maintain the ability to distinguish between each of the ECNs. "It's not one big system, what's being discussed is the bilateral linkages of all the ECNs to keep everybody's books separate but open," says Archipelago's spokeswoman, Kampschroeder.

Elaborating on the connectivity that is being discussed, TradeBook's Bang says, "We're looking to establish direct connectivity through a computer to computer interface." He adds that the connection is expected to be "an intermingling of our books to a limit order file with a sort of price priority matrix resulting in greater depth to our books, and we would be able to get a large amount of data back and forth." Bang says that the connection benefits include avoiding SelectNet fees and a faster environment with superior technology.

Island's Associate General Counsel, Chris Concannon, agrees that linking with other ECNs for after-hours trading would be beneficial but emphasizes that questions still remain as to how exactly the linkages would be formed. "We're definitely interested in avoiding any market fragmentation in the after-hours market, the question is how to do it," notes Concannon, who confirms that Island has also seen the letter of intent discussing the linkages but has not signed any agreement regarding the specifics of Island's involvement.

Customer service was also a factor in the decision to initiate the linkages, says Neil DeSena, managing director of REDIBook, "We are concerned with protecting our customers in what could be perceived as a volatile market, and the way to do that after hours is to be able to speak to your competitors." While ECNs are jumping on the bandwagon for providing after-hours trading, the networks are also hard at work addressing concerns over certain aspects of such a market.

Strike Technologies' president and CEO, Arthur Pacheco, explains, "When you have fewer participants you have the potential for more market movement and perhaps even more market manipulation, so there is the opportunity for some customer abuse in a less liquid or possibly more volatile market." Pacheco says that while Strike is waiting on SEC approval to begin after-hours trading, the best way for Strike to avoid these problems once they commence trading is to provide an open environment. "The more closed or secret the environment is the more opportunity there is for abuse," continues Pacheco, noting that Strike is also interested in future linkages for after-hours trading in order to provide the most liquid environment for its subscribers.

Whether or not these linkages have a profit motive behind them, Mark Yegge, chairman and CEO of NexTrade, emphasizes that the ECNs linking together would be in the best interest of the clients. "If you're going to be an after-hours player, you have to recognize the fact that you cannot just rely on your own order flow to provide the best liquidity for your clients," explains Yegge. "Any time you add a liquidity variable into the market, you enhance opportunities for price discovery and price improvement and that has always translated into more volume." Although Yegge would not comment on NexTrade's plans for linking, he said that there could be announcements on the after-hours issue in the future. More precisely ... he said NexTrade may announce that it plans to link

Linkages in place or not, the ECNs are staying open later and later, with NexTrade even matching trades twenty-four hours a day, seven days a week. But the issue remains that in order to provide the best execution for clients the ECNs are looking to achieve the greatest liquidity. In order to generate this, the ECNs and industry watchers concur that sharing books in the after-hours market is a good way to get there. As Meridien's Sang puts it, "With technology, especially the Internet, everyone is becoming linked and it wouldn't be inconceivable for people to wake up at three o'clock in the morning and want to trade."

Trading at all hours of the night in the U.S. isn't the only objective that these linkages are looking to achieve. The move toward globalization and opening markets abroad is also expected to bolster liquidity. "Instinet is already a member of 18 or 19 stock exchanges all over the world and ultimately their goal is to have a fully electronic trading system that can be linked to all of the exchanges worldwide, creating a virtual twenty-four hour market," says Sang. Other ECNs are moving in the international direction as well. Instinet, which trades in 40 markets worldwide, recently purchased a stake in Archipelago. Both Instinet and Archipelago are part of a consortium that acquired a stake in Tradepoint, a London-based electronic exchange, in order to broaden their scope in the international marketplace. TradeBook is also looking to get onto the international scene by leveraging its partnership with CLSA Global Emerging Markets. TradeBook expects to increase its global presence with the formation of Global TradeBook with CLSA, which will extend services to matching global equities.

NexTrade is tapping into the foreign exchange market with its alliances to GlobalNet, an equity trading system, and Valhalla Forex. They are launching Matchbook FX, LLC, an electronic foreign exchange platform. Mark Yegge, chairman and chief executive officer of NexTrade explains, "We are concentrating very heavily on our international presence. Right now GlobalNet customers can log into the system, which is linked to NexTrade and trade U.S. equities, which really helps our after hours liquidity." He adds that NexTrade is also in negotiations to extend their international trading capacity into South America as well.

With the possibility of an ever-evolving after-hours, linked, global market operating in the not too distant future, the question of how participating ECNs would distinguish themselves remains. While the specifics of linkages, pricing and timing may as yet be resolved, there is, of course, a general consensus among the ECNs that each system will be able to retain their competitive edge. "Technology and service will continue to be a critical factor in the success of an ECN," says Island's Concannon. "Each ECN uses a different platform with different software, so the ability to conform to the software and the platform quickly and the ability to respond to customer needs will be important."

So as the march down the road to a fully automated, round the clock market continues, the idea to share full depth of books during specific after-hours trading sessions is the one thing that ECNs openly agree upon. The benefits derived from such an arrangement would be concentrated on providing a liquid environment for subscribers to receive the best prices possible in an open environment. Only time will tell how successful the linkages and the after-hours market will prove to be, but 'going global' is an obvious move that ECNs will be making in the future.

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