With changes rippling through the U.S. equity markets, there are signs that a new wave of alternative trading systems (ATSs) are emerging to fill the void left by the pending mergers of the New York Stock Exchange with Archipelago, and Nasdaq with INET.
Already on the launching pad is Kansas City-based BATS Trading - which stands for Better Alternative Trading System. According to BATS Trading officials, the ATS currently is building the matching engine for its new electronic communications network (ECN), which it plans to launch in early 2006.
BATS Trading has filed to become a registered broker-dealer with the NASD and plans to file with the Securities and Exchange Commission (SEC) under Regulation ATS later this year. "We're one of a handful of new markets," says Joe Ratterman, chief operating officer at BATS Trading, who predicts the emergence of other ECNs and ATSs precipitated by the two large equity markets mergers.
The consolidation in the equity markets is motivating new entrants that contend they can offer more competitive pricing and novel features, Ratterman explains. "When there are [only] two [players] there, maybe they have the ability to raise price, and maybe there won't be as much innovation," he continues. Ratterman notes that BATS will differentiate itself with unique order types, functionality and order handling.
The Beginning of a Trend
Sang Lee, managing partner at Boston-based Aite Group, also expects to see many more ATSs popping up as broker-dealers seek to hedge their bets against routing all of their order flow into two giant liquidity pools. "I think this is just the beginning," he says.
Lee predicts the industry will see a lot of action from regional exchanges. Additionally, nonequity markets such as the International Securities Exchange - the all-electronic equity options exchange - could jump into the ring, he adds. And, some of the broker-dealers that are looking for investment opportunities could sponsor independent ATS platforms themselves, Lee suggests.
Judging from recent events, the trend already has begun. On May 4, Knight Trading announced that it was acquiring Attain ECN from Domestic Securities, a privately held company. Knight's goal is to offer a "stable, fast, competitively priced and anonymous execution platform for trading Nasdaq, exchange-listed and OTC [over-the-counter] Bulletin Board Securities," according to a press release announcing the deal.
Meanwhile, the Philadelphia Stock Exchange (PHLX), on June 16 and then on August 23, announced that six investment banks - Merrill Lynch, Citadel Derivatives Group, Citigroup, Credit Suisse First Boston, Morgan Stanley and UBS - were acquiring a combined 45 percent stake in the exchange. Also on August 23, the Boston Stock Exchange announced a joint venture with four securities firms - Citigroup, Credit Suisse First Boston, Fidelity Brokerage Company and Lehman Brothers - that will launch a new electronic stock exchange: the Boston Equities Exchange, or BeX.
According to Lee, the brokerage firms are beginning to sense an investment opportunity in the regional exchanges, which hope to compete on a more level playing field with the NSYE and Nasdaq following the adoption of Reg NMS. "They sense an opportunity in the market because of Reg NMS and also because of the two mergers," he explains.
One of the opportunities created by the adoption of Reg NMS is the ability to capture a share of market-data revenues, Lee points out. "If you are able to provide enough quotes and do a certain level of trading, you get market-data revenue from that," he says.
"We have a plan to make our market data available in a highly competitive way," BATS Trading's Ratterman says of his firm's strategy. "I can't say if it will be free or substantially cheaper than our competitors, but, definitely, it will be made available for distribution to subscribers in a highly competitive way," the COO asserts.
Currently, BATS Trading is concentrating on developing its ECN, which consists of proprietary software that takes in buy and sell orders and matches, prints and routes them. Ratterman says the ECN is based on a distributed architecture with several matching engine components running in parallel.
However, BATS Trading's founders have decided to outsource the hosting of its servers to the SAVVIS data center in Weehawken, N.J., rather than build its own data centers from scratch. "One of the reasons BATS has chosen to locate with us is that Archipelago was there, and it was a proven model to reference," says Matt Fox, vice president and manager of the financial services division at SAVVIS.
"One of the benefits to going with SAVVIS in their Weehawken data center is that Archipelago is connected," confirms Ratterman. "A subscriber that wants to route orders to Archipelago or to BATS can sit in the same data center with two ECNs - that's the advantage," he explains. "And that same data center can be used for routing orders to other equity market centers and for market-data receipt," he adds.
Under Reg NMS, equity markets like BATS Trading will need to scan other markets for the best price and route orders to other destinations if the orders can't be filled in their own order books. "We're going to outbound to other trading destinations, and if those trading destinations are supported by SAVVIS infrastructure, we'll route through that infrastructure," says Ratterman. "If not, we'll do whatever it takes to be connected," he adds.
Furthermore, SAVVIS' Fox notes, financial services firms that use the SAVVIS extranet for FIX connectivity or for accessing trading counterparts "will be able to subscribe to the BATS service over our network."
In addition to bringing on BATS Trading, SAVVIS also announced that Track Data will use the SAVVIS network to offer access to its Track ECN - which recently revamped its pricing structure to offer the highest rebates and lowest access fees in the industry, according to the release. With the ECN population plummeting from a dozen or so in the late 1990s to a handful today and the equity markets approaching a duopoly, "I think Track Data and BATS realized there was a void in the industry for these services," Fox says.
Only the Strong Will Survive
But, Aite Group's Lee warns, some ECNs may not have enough liquidity to justify their existence. "If you don't get liquidity, there are many other more-experienced, entrenched competitors that exist," he cautions, adding that new ECNs may need a broker-dealer's backing to sustain the amount of order flow needed to survive. "If you're entering the market as an ATS without clear backing from dealers, I'm not sure it's feasible," Lee says.
For example, Attain ECN now will have the backing of its new owner, Knight Trading, which is a leading Nasdaq market maker, Lee notes. And before that, Attain was affiliated with a day-trading firm run by Harry Houtkin.
In keeping with this business model, BATS Trading is counting on the support of its affiliate - Tradebot Systems, an automated provider of short-term liquidity to exchanges and ECNs. Trading for its own account, Tradebot is a key liquidity provider in U.S. equity markets and puts up significant daily volume, says BATS Trading's Ratterman. "Computers nearly make all of the trading decisions," he adds.
To jump-start the ECN, Tradebot will become a subscriber and provide liquidity to BATS. "We hope to incent other liquidity providers to put up liquidity as well," explains Ratterman, who adds that the new ECN already has a top 30 list of potential subscribers. Initially, the subscribers will have to be broker-dealers - institutions will need to go through a sponsoring broker-dealer, Ratterman notes.
www.bostonstock.com Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio