Could Revamped NYSE Fix Fragmentation?
Seeking lost liquidity, Big Board to transform market structure
June 23, 2008
A bevy of proposed rule changes from the New York Stock Exchange, designed to accelerate automation while maintaining most of the exchange's distinctive characteristics, was applauded last week by brokers anxious for a solution to mend the fragmented U.S. market.
The extent to which NYSE's waning fortunes can be turned around may depend on how effectively the new rules are implemented, both in terms of necessary technology changes and its sales pitch to Wall Street.
NYSE plans to begin making systems changes later this summer, when the majority of its proposals are expected to receive regulatory approval. In its June 11 filing with the Securities and Exchange Commission, to be published in the Federal Register within the next few weeks, the exchange says that most of the changes will be effected in the third quarter, with the remainder to be put in place by year-end.
The larger questions may be whether the Big Board can persuade Wall Street of the merits of its leap into 21st century trading and, if successful, the ultimate shape that its storied floor will take.
The hope, both for NYSE, which has seen its market share in listed stocks drop precipitously in the last few years, and for investors seeking to execute large blocks, is that the exchange will recoup some of its former depth of liquidity. "We've encountered a tremendous frustration among customers because 40 other venues trading NYSE stocks have caused enormous market fragmentation, and customers feel they have to be in so many places to execute large trades," said Doreen Mogavero, president and CEO of floor brokerage Mogavero Lee & Co.
Mogavero said her firm has offered the ability to find the other side of a trade through other floor brokers or by working with specialists representing a security. While the effectiveness of a trader-driven market has been lessened by technology that enables faster trading speeds and regulatory mandates such as Regulation National Market System, "investors are clamoring for that kind of service again," she noted.
However, returning liquidity to NYSE may be a tall order, given that the largest flow providers have either set up their own matching engines, often in the form of dark liquidity pools, or invested in competing platforms.
"The Wall Street firms who built the dark books have a disincentive to fix [NYSE], because they benefit from the fragmentation," said Richard Rosenblatt, CEO of New York-based agency brokerage Rosenblatt Securities, which supports floor brokers as well as upstairs trading.
Nevertheless, NYSE advocates say its existing components, supplemented with modernized rules and technology, could offer a solution to the fragmentation dilemma. "The exchange offers the only potential venue that can aggregate liquidity, minimize volatility and find the right price," Rosenblatt said.
Rethinking Specialists
NYSE launched its Hybrid Market in October 2006--in anticipation of Reg NMS--bringing automation to its more than 100-year-old trading floor. The model has been laden with rules that impede specialists and floor brokers, and many have found it to be inadequate. In its filing this month with the SEC, the exchange says that it "is proposing to transform its market structure and create the premier venue for price discovery, liquidity, competitive quotes and price improvement." The key elements of the proposal, according to NYSE, are redefining the role of the specialist and changing priority and price rules.
