Screen role to challenge New York’s market debutant

When Kevin Feeley takes up his position on the floor of the New York Stock Exchange tomorrow, he can expect to be the centre of attention. He will be making a market in NYX, the stock of the NYSE Group itself.

The world?s largest stock exchange completes its merger with the Archipelago electronic trading network on Tuesday and dealings in the
stock will bring an end to more than two centuries as a mutually
held club. But that is almost the least of the changes at the so-called Big Board.

Until now, trading has been exclusively in the hands of ?specialists? like Mr Feeley, of Bear Wagner, and brokers who make their deals pacing the floor of the exchange. With the acquisition of Archipelago, the NYSE is ready for a ?hybrid trading? model that combines an electronic trading platform ? conducted by computers without human interaction ? with its famous floor. It is a fundamental shift.

The NYSE is not alone. Its near neighbour, the New York Mercantile Exchange (Nymex), which dominates global oil markets, will next month begin its own revolution by offering electronic trading of its crude oil contracts side-by-side with the heaving mass of humanity in its trading pits. Jim Newsome, Nymex?s president, says he expects ?the floor will remain an active part? and notes that it was floor traders themselves who pushed for more electronic trading. And members of the Chicago Board of Trade (CBOT) will tomorrow vote on whether to give the exchange?s board the authority to look into a ?side-by-side? model for its key agricultural contracts.

In Europe, electronic trading is the norm and open-outcry floors are viewed as an anachronism. At the London Stock Exchange, screen-based trading was introduced alongside open
outcry as part of the ?Big Bang?
operational overhaul of 1986. It rapidly triumphed and the floor was closed within weeks.

?America is lagging behind. Electronic trading is inevitable ? it truly is,? says Tony LaPorta, a former pit trader on the London International Financial Futures and Options Exchange (Liffe), which switched rapidly to electronic trading in 1998 after Eurex, its all-electronic rival, stole its benchmark Bund contract.

But the NYSE is in a different league. As John Thain, its chief executive, points out, the market value of companies traded on New York?s floor is $21,000bn ? more than the Tokyo, London, Nasdaq, Euronext and
Deutsche B?rse exchanges combined. If the NYSE goes fully electronic, it would truly be the death of floor trading. Will that happen?

?People have talked about this ?death? for the last 15 years and no one has yet been right,? says John Lothian, head of electronic trading at Price Futures Group, a Chicago brokerage. ?But the confluence of the changes at these three could well make this point ? in hindsight ? one of significance.?

Doug Atkin, a former Instinet chief executive who now heads Majestic Research, suggests the future of the floor hinges on the NYSE?s battle for market share with its (fully electronic) rival Nasdaq. ?If Nasdaq makes even moderate progress, then Thain has got to go electronic,? he says. ?I think hybrid trading will last a year but I don?t think it will last much longer.?

Mr Thain says the model could last longer and the main reason for offering electronic trading is to increase volume ? the key to profitability for all exchanges, which make their money on the commissions charged on each trade. ?We traded more than 3bn shares on two occasions [last year],? says Mr Thain. ?So far this year we?ve been trading 1.7bn shares a day. If we want to trade 6bn or 7bn shares a day, we have to automate more of what?s going on on the floor, so they [the traders] don?t have to deal with orders that the computers can simply match. Whenever there are imbalances, you will be using the floor.?

He suggests that only about 200 of the 2,780 NYSE-listed stocks are liquid enough to trade electronically most of the time and that the ?vast majority? would not trade very well on screen.

Experience on the Chicago Mercantile Exchange is also instructive. In 2000, daily volume on its Globex platform averaged 137,000 contracts a day. So far this year, it has averaged 3.3m contracts a day. ?We can only go by what our customers are asking for and, right now, that?s more and more electronic access,? says Terry Duffy, chairman of the CME and a former independent floor trader.

The CME has invested more than $1bn over the last seven years in its technology. However, Mr Thain and others who believe in a hybrid model note that the CME?s floor trading volumes are also greater than they were in 2000.

Another factor pushing the NYSE is regulation. The Securities and Exchange Commission last year announced a new Regulation NMS (?National Market System?), designed to bring some common rules to the various electronic communication networks and alternative trading systems that are competing to provide a venue for stock trading. The rules will split US stock exchanges into ?slow? and ?fast? markets based on their ability to offer automatic and immediate execution of trades.

?Fast? markets will have to link with each other and match each other?s best prices in order to execute trades. For the NYSE, this opened the risk that ?fast? markets would be allowed to ignore better prices on offer at ?slow? floor-based exchanges.

Harrell Smith, head of securities and investments at Celent, a Boston-based consultancy, says: ?Without Reg NMS, the NYSE would not have been forced to merge with Archipelago or go to the hybrid model. It did that in response to the writing on the wall from Reg NMS.? He predicts the NYSE will close its trading floor within two years.

To those who witnessed the changes in Europe, electronic trading appears inevitable. It is faster and opens up trading to new participants, expanding liquidity and reducing the clubbiness that still characterises many US exchanges.

?Before, if I were going to trade eurodollars on the [Chicago] Merc, I?d call my broker, he?d call the floor, the floor broker would hand-signal the clerk, who?d tell the pit broker,? says Mr LaPorta, who now runs the Power Points trading consultancy in Chicago. ?He?d fill my order, tell the clerk, who?d signal the desk, who?d call my broker, who?d call me. You?ve now eliminated all that and given the outside man a chance ? electronic trading levels the playing field.?

But some products have proved more adaptable to the screen than others. The CME and the CBOT, its cross-town rival, have successfully transferred their financial flagship products ? eurodollars and Treasury futures respectively. Agricultural futures, which have an uneven seasonal calendar and are less liquid, have proved stickier.

?I don?t have a crystal ball but I think floors will be around for longer than people think,? says Charles Carey, chairman of the CBOT. ?With the more complex trades and products, there is still value to having somebody there.?

Mr Thain adds: ?Unless a company is very liquid, if you want to put an order in for 10,000 shares and there doesn?t happen to be 10,000 shares to sell at that price at that moment, you drive the price up …But a market-maker will fill in the extra. They can say: ?There?s 8,000 for sale and I will fill in the extra 2,000.? That?s what specialists do. They make the stocks trade in a less volatile way.? When companies move from the Nasdaq to the NYSE, he says, their volatility during each day drops by 40 to 50 per cent.

The biggest factor screaming ?inevitable?, perhaps, is that electronic trading, without the necessity of a physical location, has levelled the playing field for an exchange?s rivals and made it easier to steal products ? which drives the loser to follow suit (a process that Regulation NMS will accelerate).

Just ask Nymex. Last month its rival, the InterContinental Exchange (ICE), launched an electronic version of Nymex?s flagship West Texas Intermediate crude contract. ICE already accounts for 10 per cent of total WTI trading. It was shortly after that launch that Nymex announced its own side-by-side electronic and floor trading, due next month.

It does not work in the other direction. When ICE last year closed the London floor operated by its UK arm, formerly the International Petroleum Exchange, Nymex opened a rival London floor to entice ICE e-trading malcontents. But while ICE?s electronic trading volumes have soared, Nymex yesterday said it would close its six-month-old venture.

The final word on the future of Mr Feeley and his friends, fittingly, will be from the market. As Mr Thain himself admits: ?We will give our customers choices and the market will evolve as it will evolve. And we will let it evolve.?

Life is hectic and noisy - it?s the pits

Some smoke, some go for runs, some drink coffee and some take singing lessons. There is no single way to survive the stress of life as a commodities exchange floor trader.

Jeanette Schwarz Young has three trading jackets, in hot pink, lime green and lavender, with the legend ?Options Queen? emblazoned on the back. ?The traders sing ?Dancing Queen? when I walk past. I?m about a foot too short for this game and in these colours, when I wave my arms, the guys take notice,? she explains.

Ms Schwarz Young, 5ft 4in (163cm) tall and owner of JA Schwarz Analytics, is one of very few women in the trading pits of the New York Board of Trade, the downtown Manhattan exchange made famous in the 1983 film Trading Places.

It has just had its best-ever year and, although it is about to offer some of its financial products electronically, there are no plans to follow with its main agricultural contracts, which include coffee, cocoa, sugar, cotton and orange juice.

Ms Schwarz Young is a ?local?, who trades on her own account, dealing with other locals and with brokerage firms. ?At first I literally used to shake when I traded. When you think about the kind of money you?re putting at risk, you get scared. Eventually I learnt to stop that.?

A seat holder at Nybot since the mid-1980s, Ms Schwarz Young has various methods of coping with the stress. ?I used to go ballroom dancing but now I listen to music. Knitting was good but who has time for that now?? Her age? ?I?m not telling! One thing you cannot be on Wall Street and that?s old.?

Her day starts at 6.30am when she checks her e-mails. A mother of four, the youngest in college, she looks after her 91-year-old father. She usually arrives at the exchange by 8am when traders gather on the floor to swap gossip before the pits open.

Each commodity has its own pit ? a ring with stepped levels. Traders communicate by screaming and hand signals. Deals are scribbled on note pads and quickly entered by clerks into a computer so the price they have agreed appears seconds later on screens above them.

?Trading is multi-tasking. You?re keeping track of multiple contracts, months, spreads [difference between contract prices] and options,? says Ms Schwarz Young. ?Friday, I went long July coffee and immediately ran to the options ring and sold some calls [options to buy] as a hedge. I?m now waiting to buy puts [options to sell] on the cheap.?

As the pits close, traders check their deals have been entered correctly and head home at about 4pm. Ms Schwarz Young takes the ferry to New Jersey, then sits down at her computer to check other markets and plan the next day.

And what is the Options Queen?s maxim? ?Cover Your Ass ? 90 per cent of trading is capital preservation because if you don?t have the capital for tomorrow, you?ll be blown.?

Thain considers a European push

On which front will the New York Stock Exchange fight next?

From tomorrow morning, it is likely to be armed with a strong share price, giving it a great acquisition currency. There is speculation ? stoked by the comments of its chief executive, the former Goldman Sachs president John Thain ? that the NYSE will spend it on an acquisition spree, looking to pick up one of the big European stock exchanges or a US options exchange. But could it instead be sucked into a domestic price war with its New York rival, the Nasdaq stock exchange?

Until now, the NYSE?s main concern has been to serve its members. Now it will need to maximise profits. Doug Atkin, a former chief executive of the Instinet trading network bought by Nasdaq last year, suggests this could lead the two New York exchanges into a classic economic ?game? of co-operation or competition.

Robert Greifeld, Nasdaq?s chief executive, made clear his intention to aim directly at the NYSE?s market share when he closed the deal to buy Instinet. ?First and foremost, we have a clear and present opportunity to gain a tremendous trading share in the cash equity market for those stocks listed on the NYSE,? he said.

According to Mr Atkin: ?We are really concerned that Nasdaq is taking such an aggressive stance against the NYSE and going after that business. Our view is that if Nasdaq just sticks to its knitting and doesn?t wake up the 8,000-pound gorilla, then Mr Thain is more than willing to give Nasdaq its market and settle into a duopoly ? in return for Nasdaq letting the NYSE get on with raising prices.?

He pointed to Europe, where there has been extensive consolidation among exchanges and where trading fees are five times those charged by the NYSE and Nasdaq.

On Mr Atkin?s analysis, barriers to entry are high ? the classic economic pre-condition for a monopoly or duopoly to survive. Exchanges, particularly the NYSE, can also draw on cross-subsidies from lucrative businesses such as listing fees in which they enjoy a quasi-monopoly.

?Once you have the liquidity, it?s really difficult to start a successful competitor,? he said. ?It?s almost like [internet auctioneer] Ebay ? even if a competitor said you could auction your product with them for nothing, you are still going to lose on the price you get for your merchandise if the liquidity isn?t there.?

Mr Thain disputes this analysis: ?On the trading costs side I think the markets will remain very competitive,? he says. ?It?s not very hard to create new exchanges and new marketplaces. It?s hard to create the liquidity pool but it?s not very hard to create the marketplace. That means that you don?t have as much pricing power as you would think.?

Citigroup, the world?s largest financial services company, has said it will launch its own electronic trading network, in an implicit hedge against the risk that the two big exchanges would raise prices.

?Our industry is so competitive and you can see these hedges that are being taken by the broker-dealers and hedge funds,? says Bill Cline, head of the exchanges practice at Accenture. ?That makes large fee increases from the exchanges unlikely.?

He thinks Nasdaq is unlikely to seek to compete on price and will instead continue to emphasise what it regards as its superior electronic trading system. ?This is where the question of the NYSE?s trading floor will ultimately come in, because it?s more expensive and that cost ultimately has to be reflected in the total cost of trading,? he says.

Mr Cline draws a comparison with the Chicago Board of Trade, which fought off price competition from Eurex by lowering its own fees ? in part by offering electronic trading.

This could be a problem. One industry veteran said he ?would not want to be in John Thain?s shoes?, as the multiples on exchange stocks show that the market is expecting the industry to continue to grow very fast. Chicago Mercantile Exchange has seen its share price multiply tenfold since going public and trades at much the same earnings multiple as Google.

But to many insiders, the business looks mature and cyclical. ?The kind of multiple the NYSE and Nasdaq will be selling at contemplates growth in excess of what?s possible,? says one, ?so they?ll be left to try to grab from each other?.

Their only other way to build profits is via acquisition ? either to diversify products, or to diversify geographically.

Exchanges make their money from trading volume. Revenue generated from pumping new products through the trading infrastructure NYSE acquired in the Archipelago deal would pass almost directly to the exchange?s bottom line.

This would point to equity options. According to the New York-based International Securities Exchange, trading volumes in equity options have tripled since 2000, making them an exceptionally high-growth product. Moreover, they are easily adapted to trading over the NYSE?s existing stock-trading platforms.

Finally, there is the option of plunging into the consolidating market for European exchanges. Mr Thain does not hide his interest in this. ?There?s an opportunity to combine liquidity pools and offer investors the ability to trade across both of them,? he told the FT. ?You can combine platforms and you can also reduce your costs. Euronext has consolidated Amsterdam, Brussels and Paris and Lisbon and put them all on one platform, and consolidated their liquidity pools.?

The safest bet, wherever the battle takes the NYSE, is that the huge change that starts tomorrow will not be its last. The game of consolidation must play out for a while longer yet.