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News October 4, 2004 Issue

NYSE Hybrid Market Debated at ICI's Equity Markets Conference

Not surprisingly, the NYSEís August 2004 announcement that it plans to develop into a "hybrid" market, offering full-fledged electronic as well as floor-based trading, was a key topic of conversation at the ICIís recent Equity Markets Conference.

Several conference participants noted that although the buy-side had been asking the NYSE to provide greater automation for years, the exchange didnít act until the SEC proposed Reg. NMS last spring. During the conference, however, NYSE officials emphasized that the drive to automate stemmed from customer requests and for competitive reasons. The exchange "is not going to want to lose market share" by being in manual mode during a big part of the day, said NYSE senior vice president Robert McSweeny. NYSE CEO John Thain, who spoke during lunch, noted that the buy-side had been telling the NYSE that they didnít like the fact that they couldnít trade instantaneously and electronically on the exchange. "If we didnít listen" to those concerns, said Thain, "youíd move your trading somewhere else." He acknowledged that some viewed the announcement as merely a reaction to Reg. NMS. "Thatís not true," he said. "We would do it anyway, because you would take market share away from us and trade it somewhere else if we donít provide that capability."

Speakers debated whether the SEC would adopt the fast/slow quote (as opposed to market) approach, and if so, how "fast" would be defined. SEC Division of Market Regulation deputy director Robert Colby described a fast quote as "a quote you can execute without the tender loving hands of an individual." Fidelity general counsel Eric Roiter argued that the SEC shouldnít attempt to define a fast quote. "I just donít think government is in a position to embed that in a rule," he said. "The law cannot keep up with technological change." Investors, he said, will reward market makers that are efficient and transparent and do a good job of regulating themselves. "Iím flabbergasted to see . . . this debate reduced to how many quotes can dance on the head of a pin," he said.

Participants also questioned whether automated NYSE quotes would "flicker" in and out of manual status. As ICI associate counsel Ari Burstein put it, "how many times can a fast quote go slow and still be fast?" Thain said that the goal was to be "electronically accessible virtually all the time." However, if there is an order imbalance, he said, specialists would deal with it on the floor.

Participants criticized NYSEís proposed automated sweep function, which would effectively protect "top of book" but not "depth of book" ó in other words, it would sweep only the first trade, but would not sweep down the book. Burstein said heís been hearing that traders are planning just to "walk the book" and not use the NYSEís sweep function. Kevin Cronin, director of equity trading for AIM Investments, agreed: "Is this sweep mechanism really interesting to me? No."

There was also concern about the lack of details provided in the NYSEís proposal (a point that several commenters had noted in letters). For example, Roiter said he didnít see the NYSEís proposal as significant progress, calling it an "incomplete proposal" that did not provide clear details of how the automation would work.

Of course, there was much discussion of Reg. NMSís proposed trade-through and the controversial opt-out exception. NASDAQ president and CEO Robert Griefeld continued to criticize Reg. NMSís trade-through requirement. Depending on how the ruleís parameters are set, said Griefeld, potentially 58 percent of NASDAQ trades and 45 percent of NYSE trades could be exempt from the trade-through rule. Based on those statistics, he questioned whether trade-through would "actually work in the real world."

However, Colby seemed to stick up for trade-through, asking "why would anyone post a limit order if they arenít going to be rewarded for it?" With respect to the ruleís controversial opt-out exception, he said that the best view of opt-out is that it is "a safety valve." At its worst, he said, it could be viewed as "a huge steam leak." Thain clearly took the latter view, urging the audience not to opt-out, "even if the SEC allowed it." Thereís no reason why you wouldnít want to get your customers the best price, he said. If firms opted-out, and didnít get the best price for their customers, he predicted it would be "the future mutual fund scandal."

In her keynote speech, SEC Division of Market Regulation director Annette Nazareth said that the SEC will address market data issues in a broader SRO structure concept release, rather than as part of a Reg. NMS adopting release. She also predicted that "in the next few months" the staff will recommend that the SEC propose rules pertaining to the governance, administration, transparency, and ownership of SROs.