Nasdaq to Redesign Trading
The Nasdaq Stock Market is launching a major restructuring of its trading operations in an attempt to increase price competition for investors, grant anonymity to institutional investors and give dealers more control over their trades.
The plan, dubbed the “Next Nasdaq,” would create a central market for customer “limit orders”--stock orders at pre-specified prices that now interact only within a particular dealer’s file. It also would combine Nasdaq’s two principal electronic trading systems, SelectNet and the Small Order Execution System, into one system with more advanced technology.
“We improve our competitiveness by making the market efficient and fair for investors,” said Nasdaq Executive Vice President Patrick Campbell.
The board of Nasdaq, the nation’s second-largest stock market, voted earlier this week to forward the plan to the board of the parent body, the National Assn. of Securities Dealers, for an Oct. 9 review. If the NASD approves it, the Securities and Exchange Commission will issue the proposal for public comment before deciding whether to adopt it. The SEC regulates U.S. stock markets, including Nasdaq.
Under Frank Zarb, NASD’s chief executive since February, NASD has been vying to improve its ability to compete with the New York Stock Exchange, the Instinet private trading system and other alternative systems. NASD has sought to enhance its technology, recruit overseas companies and improve its responsiveness to investors, dealers and corporations.
Limit orders now compete in a limited field because they interact only with limit orders placed by customers of the same dealer. They also are sometimes forwarded by dealers to private trading systems that compete with Nasdaq. The central limit-order file would be voluntary under the Nasdaq plan, so dealers could continue keeping their own limit-order files, Campbell said.
“A central limit-order market would result in better stock prices for investors and give them more access to trading information,” Campbell said. “This could spur them to place more trades, and institutional investors especially would be able to guard their strategies by trading anonymously.”
Nasdaq-listed companies, institutional investors and some brokerages have been pushing for a central limit-order market, Campbell said. A Security Traders Assn. survey of institutional investors found that anonymity was the trait they found most desirable in a trading system, he said.
Currently, an institutional investor must be identified in Nasdaq trades, though not in trades on a private trading system.
SelectNet, which accounts for about two-thirds of all dealer-to-dealer orders placed on Nasdaq, is now used by most mid- and large-size dealers. The controversial SOES, on which about 20% of all dealer-to-dealer orders are placed, seeks to put small traders on an equal footing with larger rivals.
“This would simplify trading and give market makers more control over their trades,” Nasdaq’s Campbell said. “It also would help stop backing away.” Market makers are dealers who stand ready to buy or sell securities on behalf of investors or themselves.
Dealers sometimes “back away,” or fail to honor posted quotes, because of the difficulty they have in trying to reconcile quickly the prices of orders coming in on two trading systems, Campbell said.
SelectNet has been overwhelmed by price quotes since Nasdaq started phasing in order-handling rules earlier this year that have narrowed trading spreads--the difference between the buying and selling prices of a stock.
As for SOES, dealers have long complained that small traders exploit the system by placing rapid-fire trades whenever stock prices fluctuate.
Nasdaq will scrap efforts to replace SOES with the “Naqcess” system, Campbell said. For years, former NASD Chief Executive Joseph Hardiman unsuccessfully pushed Securities and Exchange Commission Chairman Arthur Levitt to adopt Naqcess.
A stock-traders group Friday praised Nasdaq efforts to combine the two trading systems but said a central limit-order market could narrow dealer profits and dry up market liquidity.
“The two plans should be decoupled because there is a dealer consensus about combining the two systems, while the limit-order file is controversial,” said John Tognino, president of the Security Traders Assn. “The limit-order file could be a disincentive for any dealer to ultimately risk capital.”
