Electronic Market Microstructure

Electronic trading strategies, strategies strategies… Everyone, including market service providers, like exchanges; broker-dealers; market utilities; and the buy side are hiring buckets of people to sit and scratch their heads and come up with an “electronic trading” strategy; which by the way they need to! Well it is going to be interesting, there has been so many products and services developed over the last few years; some innovative and useful, others not so much, that there is a quagmire of capabilities to sort through. I believe this situation was precipitated by several factors including; the T+1 mandate followed by the “promise” of STP, then followed by Basel II and continued with The Agency Disclosure Act, FAS 133 and now finally Reg. NMS. All these initiatives are certainly good and necessary, but they have clogged up a log-jam of electronic capabilities that we are now all piecing together. There are so many that:

There are small companies out there that have sophisticated algorithmic capabilities that support program trading, basket trading and crossing networks that no one has heard of.

I believe that underlying the regulatory mandates mentioned above there are common implementation characteristics. Some of the main one’s being transparency, better transaction times, and lower operational risk; which all lead to automation, and thus some sort of electronic implementation. This is why I believe there is such a back log of capabilities. Not to say that they would have not naturally have gone electronic anyway, but maybe not so dramatically and in such mass. What we are now seeing is the major players are sifting through all the surplus electronic capabilities and determining how they fit into their overall “electronic trading strategy”. Thus we are seeing a large and systemic consolidation in the electronic trading area. For instance, when CitiGroup bought Lava, you saw JPMorgan buy Neovest quickly and then BoNY bought Sonic so they were all covered on the program trading front. I believe this will continue.

The following are some recent consolodations that are of importance to the area of electronic trading.

NASDAQ acquired the Inet ECN: NASDAQ Aggregate its purchased liquidity, with approval from the SEC. It paid nearly a billion for Instinet last year. Then the exchange acquired the Brut ECN in 2004 from SunGard for nearly $200 million. Now it is time to reap even more rewards for this strategy. This might be a case when 1+1 does actually equal 3. System integration in NASDAQ-listed stocks will occur on a security-by-security phase-in currently scheduled for 28 August 2006. NYSE-, Amex- and regional-listed securities will be integrated on a single date, currently targeted for 1 October 2006.

No doubt this integration will create a single, much larger, book of liquidity, resulting in increased order interaction, execution speed and fill rates. The new system will provide improved execution quality and speed while maintaining the attributes of Market Center.

NYSE has acquired MatchPoint Trading: MatchPoint is a company specializing in call market trading and technology. It provides a proprietary electronic equity crossing system that matches aggregated orders at predetermined and distinct times, at prices that are derived from the primary market for securities. The technology can operate multiple matches each with a unique benchmark pricing model and can also process internal crosses for single participants and seamlessly enables residuals to participate in scheduled crossing sessions.

MatchPoint’s capabilities, I believe, will increase NYSE’s electronic execution facility in terms of speed and volume and may attract more program and basket trading bypassing specialist in the areas. It will be a very good compliment to the functionality of Archipelago if they are to integrate.

Thomson TradeWeb has acquired LeverTrade: A provider of Web-based fixed income management systems for the retail marketplace. LeverTrade was formed in August 2005 when IT consultancy LeverPoint acquired a major interest in Global Trade Technologies and formed the unit. The firm provides bond trading software to medium to large-sized bond trading firms in the US. Through LeverTrade’s retail fixed-income marketplace, financial advisors and retail representatives from firms search commingled inventory from over 30 broker-dealers and generate orders that flow to their internal trading desks.

This is a big move for Thomson; they basically bought a large part of the retail fixed-income trading business. Thomson and LeverTrade want to be the destination for clients looking for an end-to-end solution for all electronic fixed-income trading. With this acquisition they are well positioned.