Nasdaq Beats SEC to Punch On Compression
March 10, 2008
The National Securities Clearing Corp.'s (NSCC) proposal to eliminate trade compression has not yet been approved by the Securities and Exchange Commission, but the Nasdaq Stock Market is not waiting for the regulator to take action.
Nasdaq, perhaps with an eye to setting up a competing settlement house, last week announced that it will no longer compress trades executed on the exchange for submission to the NSCC for clearing. "Firms need to ensure that their systems can handle the trade comparison and the additional volume of contracts from Nasdaq's elimination of compression," noted the exchange.
Broker-dealers engaging in high-frequency, high-volume trading strategies often aggregate, or compress, buy or sell orders into a single trade to submit to their clearing firms, or, for self-clearing broker-dealers, to the NSCC. The approach saves clearing and settlement costs--important for electronic communications networks (ECNs) and high-volume, low-margin brokers--which typically are levied on a per-trade basis. The NSCC proposed eliminating the practice in April 2006.
Although the proposal did not generate an immediate reaction from the industry, more than a dozen brokers met with the SEC in October to tout the benefits of compression, and discussions between the parties have reportedly been ongoing. The firms include Citigroup subsidiary Automated Trading Desk, BNY Brokerage, Knight Capital Group, UBS, Wedbush Morgan Securities, Getco, and the BATS Trading and Direct Edge ECNs.
Nasdaq, which according to Tabb Group matches 40 percent of U.S. stock trades, has in effect bypassed that process. Nasdaq officials were unavailable for comment.
Noting that many firms compress with Nasdaq, Leonard Amoruso, senior managing director and general counsel at Knight Capital and the informal leader of the group pressing to maintain compression, said that "this certainly could affect a lot of people."
Nasdaq's deep liquidity and fast trading system make it a favorite of the electronic trading firms that are likely to compress, aggregating into a single trade hundreds or even thousands of buy or sell orders.
Amoruso said that Knight clears through Merrill Lynch & Co., which will now have to submit the uncompressed trades executed at Nasdaq to the NSCC, resulting in higher fees. Clearers typically pass on such fees to clients, either by imbedding them or attaching them to the clearing charge. Customers who want to avoid higher costs will likely seek to renegotiate their clearing contracts.
"Nasdaq is a big counterparty," added Amoruso. "This could have a significantly negative impact on cost savings."
For Nasdaq, the move may be a part of longer-term plans. In October, Nasdaq agreed to purchase the Boston Stock Exchange (BSE), which owns one of the two dormant clearing agency licenses in the U.S. Nasdaq locked up the second license a month later, when it announced it was buying the Philadelphia Stock Exchange. Neither deal has closed.
At the time of the BSE deal, Chris Concannon, EVP of U.S. transaction services at Nasdaq OMX Group, said that Nasdaq plans to use its license to clear and settle its own trades rather than its existing, non-registered clearing system that requires third parties such as NSCC's parent, the Depository Trust & Clearing Corp. (DTCC). Concannon said then that the exchange anticipates costs savings beginning in October 2008, and an eventual reduction in settlement costs of as much as $14 million.
