Schwab, Markets Battle Centralization of System
America’s biggest discount and online broker squared off against Wall Street’s top securities firms Tuesday over the need for a central system to display and process stock orders from all U.S. markets.
The heads of the New York Stock Exchange and Nasdaq market joined discounter Charles Schwab in opposing centralization as anti-competitive, while the big brokerages’ chief executives argued that increasing market “fragmentation” hurts consumers and threatens U.S. stock market supremacy.
The debate came at a hearing in New York by the Senate Banking Committee on regulatory proposals to overhaul the structure of U.S. stock markets.
Recent years have seen a proliferation of upstart electronic markets, called electronic communications networks, or ECNs, which compete for investor orders with the NYSE, Nasdaq dealers, the American Stock Exchange and the regional exchanges.
Securities and Exchange Commission Chairman Arthur Levitt and others have expressed concern that because the markets are not required to interact with one another, investors may miss the opportunity to find the best buying or selling price for their stock.
“This increased market fragmentation impedes the price-discovery process and diminishes transparency, liquidity and, ultimately, best execution of customers’ orders,” said Philip J. Purcell, chairman of Morgan Stanley Dean Witter.
What some call fragmentation “we call . . . competition,” countered Schwab, founder of Charles Schwab & Co., the leading online broker. He drew an analogy to the Internet, which functions well despite lacking a central control system.
“A monolithic structure would, in my opinion, stifle competition and innovation, and perhaps cause alternative systems to move offshore,” NYSE Chairman Richard Grasso said.
But Merrill Lynch Chairman David Komansky said a central market would not only ensure that all customers get the best price but would create the deepest possible pool of liquidity, a source of strength in bad times.
The SEC, in a “concept release” last week, laid out six alternatives for linking markets electronically. The most sweeping would be to require all orders to be funneled into a “consolidated limit-order book,” a computerized central facility that would automatically execute trades in order of price and time of arrival.
The mildest alternative would require more public disclosure of order-routing arrangements between brokerages and markets and more information about quality of execution--that is, the kind of price and service that investors obtain from a market or brokerage.
Several large brokerages also contend that market regulation is fragmented and are pushing for a single, independent regulator to consolidate the surveillance work done by the separate self-regulatory units of Nasdaq and the Big Board.
It promises to be many months, at least, before the SEC takes any action. The banking committee, meanwhile, is not considering any particular legislation but simply exercising oversight.
Much of the market-structure dispute among firms with big institutional clients--Morgan Stanley, Goldman Sachs and Merrill Lynch, for example--and pure retailers such as Schwab boils down to how much each party should be required to tip its hand with regard to stock orders they get from customers.
As Grasso put it jokingly, “I want to see everything that’s in the marketplace, but I don’t want anybody to see mine.”
Mainline Wall Street firms contend that Schwab and other discount and online brokers hide retail price information either by matching incoming buy orders with sell orders in-house--a process called internalization--or by directing their clients’ trades to firms that pay for such order flow.
But Schwab noted that large institutional orders are often “held close to the vest by floor brokers and specialists” and are even given trading priority over retail orders regardless of price.
Schwab also complained that retail investors must pay exorbitantly for real-time market data controlled by the exchanges.
“The public is charged a monopoly toll for its own information,” he said.
Committee Chairman Phil Gramm (R-Texas) seemed to oppose a centralized market facility, suggesting that its members might squelch innovation by trying to limit new entrants.
However, Sen. Charles E. Schumer (D-N.Y.) worried that if fragmentation continues, foreign markets might draw business from U.S. markets and eventually allow London or Frankfurt, Germany, to seize the title of the world’s financial hub, becoming, as he called it, “the alpha market.”
Noting the amount of self-interest being displayed during Tuesday’s testimony, Nasdaq Chairman Frank Zarb quipped, “If I had to design a flag for the industry, I’d have to know the Latin for ‘What’s in it for me?’ ”
