As Instinet and Island try and form a SuperECN, industry insiders wonder how it will affect Nasdaq's SuperMontage.
The Hatfields and the McCoys. The Allies and the Axis Powers ... Instinet versus Island. Okay, okay, perhaps putting the two largest ECNs into the same category as those legendary enemies is a bit of a stretch. But since its launch in 1997, Island has been a major thorn in Instinet's side, eating into the Nasdaq market share of Instinet's ECN by offering a high-speed matching engine combined with cut-throat prices. In fact, Island usurped Instinet as the largest ECN late last year, and held onto the top spot until Instinet regained its kingpin status in May.
Most recently, however, news emerged that these heated rivals - challenged by the economy and faced with the prospect of having to square off against Nasdaq's SuperMontage network in the near future - have formed a merger. The all-stock transaction, valued at $508 million and scheduled to close in the second half of this year, calls for Instinet's shareholders to acquire 25 percent of Instinet's common stock. Following the close of the deal, which still requires regulatory approval, Instinet intends to divide its businesses into two distinct operating units: a global-agency-brokerage unit run by current Instinet Chief Operating Officer Jean-Marc Bouhelier and an ECN unit headed by current Island Chief Executive Officer Matt Andresen (see chart). More importantly, the merger will unite two huge liquidity pools and eventually result in the creation of a single, integrated matching engine.
Combined, Instinet and Island will account for roughly 24 percent of Nasdaq's share volume, and will undoubtedly form a long-term threat to the success of SuperMontage - the advanced order-display and execution network Nasdaq intends to launch on July 29. SuperMontage, which will swallow up Nasdaq's SuperSoes and SelectNet trading platforms, will account for approximately 35 percent of Nasdaq's volume from its inception, according to statistics compiled by the research and consulting firm Celent Communications. But, as a result of the Instinet/Island union, SuperMontage will face stiff competition for order flow from a mega-ECN that will flaunt a diverse array of customers, including Instinet's institutional-investment firms and market-maker clients and Island's direct-access-trader subscribers.
Via its acquisition of Island, Instinet - in addition to beefing up its already formidable presence in the over-the-counter market - will immediately inherit the title of the largest marketplace for the trading of exchange-traded funds. Island has steadily grown its ETF business, and now outdistances the American Stock Exchange - the home market to a variety of ETF contracts - in the trading of the QQQ. Island now regularly accounts for more than one-third of the daily volume of the QQQ, the open-ended mutual fund that is the Amex's most popular ETF.
"I think this merger will definitely make (Island) even stronger in ETFs, not only in the QQQ but also in Spiders and Diamonds," says Sang Lee, an analyst covering e-trading at Celent Communications. "Instinet has made a small push into ETFs, and when you combine Island's success with Instinet's volume, I think that the Amex should certainly be worried."
In contrast, Lee is skeptical about Island/Instinet's potential to eat into the market share of Nasdaq's SuperMontage - a network that will display the five best bids and offers for every stock listed on the Nasdaq.
BATTLE OF THE TITANS
Celent, in a report it published this spring on the potential impact of SuperMontage, predicted that Nasdaq's network would account for 70 percent of Nasdaq's volume by 2005. That report obviously was authored prior to the Instinet/Island deal, but Lee says that Celent is standing by its projection, even in the wake of the merger news. During the time it takes the ECNs to finalize all the details of the merger, he says, SuperMontage will quickly grow its market share. "We do believe that this merger is occurring late enough for SuperMontage to attract enough liquidity ... and once it gets it, (Nasdaq) is not going to lose it," Lee predicts. "Liquidity begets more liquidity ... and by the time that Island and Instinet figure out what to do, SuperMontage will have probably close to a 50 percent market share."
The Instinet/Island union, he adds, was unquestionably driven largely by the imminent launch of SuperMontage. "I don't believe they saw SuperMontage as a potential competitor. I think they saw it as the competitor. You can't ignore a platform that will have roughly 35 percent of the Nasdaq market by the time it goes live," he says.
Island's Andresen retorts that the merger was fueled by the ECNs' desire to provide "greater efficiency and greater liquidity" to their clients, and not by fear of being overrun by SuperMontage. Island, he says, sees SuperMontage as an "electronic-agency brokerage" that specializes in order routing, rather than as an ECN killer. Noting that Island currently matches roughly 95 percent of its orders directly over its own trading platform, Andresen says that SuperMontage needs Island's participation much more than Island needs to participate in Nasdaq's network.
"At the end of the day, it's not terribly relevant to us whether we get the next liquidity-taking order from someone over SuperMontage or from someone direct over our system," he says. "But (if Nasdaq does not) provide access to Island, SuperMontage will certainly be at a grave disadvantage versus Archipelago or Lava (Trading), two companies that provide (order-routing) access not only to SuperMontage but also to Island."
Island still has yet make a final decision on whether to post its Nasdaq quotes on SuperMontage, and Instinet has also thus far shunned Nasdaq's trading network. This April, Island stated its intention to display its OTC prices on SuperMontage, but changed its mind in May when Nasdaq announced its intention to implement a new set of regulatory fees that would be based, in part, on the number of quote updates a participant makes on a daily basis.
Island, which is responsible for nearly one out of every four Nasdaq quotes, reacted to this news by backing off of its pledge to participate in SuperMontage. "We were going to lend our support to SuperMontage, allowing their routing engine to have access to our liquidity. But since that time, they have instituted a set of fees, whereby they are attempting to defer all of the costs of regulating their market onto Island ... and its not in our customers' best interests to pass those costs along to them," Andresen says.
However, Lee says that it is likely that the Instinet/Island tandem will post their Nasdaq quotes on SuperMontage - at least on a "temporary basis." By uniting with Instinet, he says, Island will have more leverage to negotiate a cheaper fee package with Nasdaq, making it more feasible for them to display their prices on Nasdaq's network. But once the Instinet/Island team is settled, Lee speculates, it will probably move its quotes away from Nasdaq and onto another market - such as the Cincinnati Stock Exchange or the San Francisco-based Archipelago Exchange.
It remains unclear whether the Island name will survive the merger. But Instinet's Bouhelier says that regardless of what the firm's ECN unit is called, it will yield benefits from combining a pair of "complementary" businesses.
"We are very institutional driven and we tend to have big volumes with stocks that have strong institutional backing. Island, on the other hand, tends to have good volumes in some of the smaller market-cap stocks ... Also, they have very complementary customers to our customers. They have historically been very strong with professional traders, program traders and, more recently, with market markers. We have historically been very strong with institutions, hedge funds and market makers," he says. "So when you look at combining the two entities, it actually makes our presence across the market much deeper and much broader than if we were to operate separately."
|1. Ed Nicoll
|Chairman of Island
|2. Mark Nienstedt
|3. Jean-Marc Bouhelier
|COO of Instinet
|COO of Instinet's Global Agency Brokerage Unit
|4. Matt Andresen
|CEO of Island
|COO of Instinet's ECN Unit
|5. Andre Villeneuve
|Chairman of Instinet's Board