George Sofianos
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Transcript of George Sofianos
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NYSE and the Specialist System
George SofianosApril 23, 2004
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Challenges facing the NYSE Erosion of traditional client base Regulation NMS proposal
Trade-through rule Access fees Sub-penny trading Market data
Electronic trading Making a “hybrid” model work Liquidity quote NASDAQ escalates the
competition Dual-listing initiative SuperMontage trading
Final rules will determine how NYSE evolves
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60%
89%
81%
69%
50%
55%
60%
65%
70%
75%
80%
85%
90%
95%
100%
Jan-
00Fe
b-00
Mar
-00
Apr-
00M
ay-0
0
Jun-
00Ju
l-00
Aug-
00Se
p-00
Oct
-00
Nov
-00
Dec
-00
Jan-
01Fe
b-01
Mar
-01
Apr-
01M
ay-0
1Ju
n-01
Jul-0
1Au
g-01
Sep-
01O
ct-0
1N
ov-0
1D
ec-0
1Ja
n-02
Feb-
02M
ar-0
2Ap
r-02
May
-02
Jun-
02Ju
l-02
Aug-
02Se
p-02
Oct
-02
Nov
-02
Dec
-02
Jan-
03Fe
b-03
Mar
-03
Apr-
03M
ay-0
3
Jun-
03Ju
l-03
Aug-
03Se
p-03
Oct
-03
Nov
-03
Dec
-03
Jan-
04Fe
b-04
Mar
-04
Erosion of traditional client base
50,000 share plus averages 2000: 85.3% 2001: 78.6% 2002: 73.9% 2003: 63.5%
Sources: Through Dec.2000 NYSE Monthly TAQ Data; Jan.2001 through Sept. 2002 FITCH Data; beginning Oct.2002 NYSE Daily TAQ Data.NYSE commons and warrants share volume reported to the Tape. All Tape hours
50,000 shares plus
Less than 4,000 shares
Q. Where have all the large blocks gone?A. To the upstairs broker-dealer market.
NYSE share of trading volume in listed stocks
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Distribution of trading volume in NYSE stocks
Other exchanges
4%
Nasdaq InterMarket
14%NYSE78%
ARCA1%
Chicago3%
3%
0.4%0.7%
10%
0%
Broker-dealers
Posit Liquidnet Other ECNsand ATSs
Seeing through Nasdaq InterMarket
Single-counted share volume, internal matches only, all hours, excluding ETFs.Liquidnet estimate from Business Week Online, January 26, 2004: 19 million shares daily, two-thirds in NYSE stocks. We
assume double-counted.Posit estimate from ITG website assuming 65% listed.
March 2004 ECNs and other ATS
remain marginal ARCA only 1% POSIT 0.7% and falling Liquidnet 0.4%
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The NYSE “hybrid” trading platform
electronic trading
floor brokers
specialists
Electronic limit order book
Symbol XYZ
Buy Qty Price Sell
Qty$33.0
41,100
$33.03
1,200
$33.02
1,000
$33.01
3,000
$33.00 3,000
2,000 $32.963,00
0$32.9
51,20
0$32.9
41,50
0$32.9
3800 $32.9
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electroniclimit orderbook Quoted
spread
Offer
Bid
Displayedliquidity
Non-displayedliquidity
NYSE Direct+® auto-ex
Figures are hypothetical.
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NYSE LiquidityQuote, 28 DJIA stocks1
15,600
6,000
15,600
6,000
10,400
10,400
0 5,000 10,000 15,000 20,000 25,000 30,000
NYLQ Bid -6c-5c-4c-3c-2c-1c
Inside Bid 1.5c
Inside Ask +1c+2c+3c+4c+5c
NYLQ Ask +6c
Shares
Liquidity in the book Additional liquidity
Inside spread, 6,000 shares: 1to 2¢
NYLQ spread, 26,000 shares: 13 to 14¢
1. We assume depth is equal at bid and ask (both at inside and liquidity quote); NYSE only provides combined bid and ask information. Data as of November 20032. Estimates from Goldman Sachs trading cost model, equally weighted, individual stock estimates range from 3¢ to 28¢ (UTX)
NYSE LiquidityQuote (NYLQ) includes 40% additional liquidity displayed by specialist and floor brokers
Goldman Sachs estimated spread2, 26,000 shares, one-hour trading horizon:
10¢
Q. How can the NYSE make LQ more competitive?
A. ?
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The value of the trading floor
99%
62%
1%
38%
0%
20%
40%
60%
80%
100%
Orders Volume
electronic book
floor brokers
Large, difficult orders choose floor brokers 40% of volume
Why use a floor broker? Non-displayed liquidity Subtle exchange of information Ability to better predict short-term alpha Ability to better time executions Direct access (independent floor brokers)
Floor brokers representing non-displayed liquidity
NYSE provides a choice Electronic book Floor brokers
Most orders choose electronic
Displayed liquidity Small, easy orders
* Source: NYSE, November 2003
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Can the NYSE “hybrid” model succeed? NYSE has all the needed ingredients
80% of trading volume Commitment to fast electronic trading for easy
flow at retail inside quote An institutional quote Relatively efficient access to non-displayed
liquidity Additional liquidity provision by specialist
How make all these ingredients work together?
Competition, pennies, electronic trading, scandals, changed the economics of the NYSE, of the specialists and of floor brokers
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The problem with the specialists systemBuy-side perspective: Large institutional investors Problem with trading through a specialist
Specialist proprietary trading and conflict of interest How is information being used?
Exactly the same problem buy-side has in trading through any upstairs broker-dealer
But upstairs broker-dealers provide a valuable service to the buy-side that counterbalances this problem
Liquidity for large difficult transactions Specialists do not provide a similar valuable service to
the buy-side Liquidity at the inside quote, to smoothen short-term fluctuations
in price Institutions that trade in large blocks do not care much for this! Perhaps good for individual investors….
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How fix it? Pull the specialist out of the inside quote Get the specialist provide liquidity where it is most
needed Large difficult trades At the NYSE LiquidityQuote?
For this to succeed must get the specialist closer to the upstairs broker-dealer desk
Chinese Walls!
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The two papers on specialist trading Roger and Jerry
Liquid stocks in specialists’ portfolios subsidize illiquid stocks Maybe a good thing but not sustainable in a competitive environment
Pooling or separating equilibrium? One of the reasons NYSE’s market share is lower for liquid stocks
Larry and Jay Emphasizes sensitivity of specialist trading behavior to the rules of
the game Resilience of specialist profitability to changes in the rules
Encouraging in the face of imminent dramatic changes Specialists are good short-term traders
Will they be able to provide liquidity to large blocks – where it is most needed?
What changes must take place to make it easier for specialists to provide liquidity to large blocks?
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