FOOL PLATE SPECIAL
An Investment Opinion
ECN Pact Should Improve After-Hours Trading Louis Corrigan (TMF Seymor)
September 16, 1999
After-hours stock trading for individual investors just got a little better. Maybe.
A group of eight competing ECNs (electronic communications networks) that have led the charge to extend the trading day beyond the traditional 9:30 a.m. EST to 4:00 p.m. EST time period announced today they've reached an agreement to create a linked network among themselves. This move should help address the concerns of critics, like myself, who have feared that the lack of liquidity and absence of a unified system for discovering the best prices among competing but isolated ECNs would make it hard for individuals to get a fair deal outside the regular trading day.
The non-binding memorandum, first circulated in late August in response to widespread concerns, was signed by all of the major ECNs. These signatories include the two dominant players: Instinet, a unit of Reuters Group PLC's (Nasdaq: RTRSY), and Island, a subsidiary of online broker Datek. Other participants include Bloomberg's Tradebook; BRUT, which is backed by Goldman Sachs (NYSE: GS), Knight/Trimark (Nasdaq: NITE), Merrill Lynch (NYSE: MER) and Morgan Stanley (NYSE: MWD); Archipelago LLC, which is backed by E*Trade (Nasdaq: EGRP) and Goldman; MarketXT, Inc., which has strategic partnerships with Salomon Smith Barney, Morgan Stanley, Herzog Heine Geduld, and Bernard L. Madoff; and REDIBook, a unit of Spear, Leeds & Kellogg which, is being revamped under an agreement with Fidelity Investments, Donaldson, Lufkin & Jenrette (NYSE: DLJ), and Charles Schwab (NYSE: SCH).
Today's agreement amounts to a promise by each ECN to negotiate with the others to display its orders. Although these new electronic trading networks are essentially competing with the New York Stock Exchange and the Nasdaq, they currently amount to discrete -- and tiny -- markets once these major exchanges shut down their order-routing and trade-reporting systems. An order placed by an investor on Island would not show up on MarketXT, for example. Instead, the Datek investors who provide Island's order flow would essentially be limited to trading among themselves.
Such market fragmentation isn't good for investors who depend on liquidity and price discovery to get the best prices whether they are buying or selling. Let's say you want to sell 100 shares of America Online (NYSE: AOL). The best offer listed on one ECN might be $90 a share whereas another ECN might show a buyer willing to pay $90 1/2. Obviously, you would like to be able to see both bids. At least in theory, this new pact would create such a transparent national order display system for the participating electronic networks. Indeed, it could even create a unified order book where all investors could see not just the best bid and ask prices but all limit orders for a particular security.
What's not clear from today's announcement is how easy it will be for an investor to actually get a trade executed at that best offer or best bid price. For example, if you're a Schwab customer whose after-hours limit order flows to REDIbook, will you actually be able to have your order matched with one funneled through BRUT, or will you have to have access to BRUT or hope that the buyer or seller can come find you on REDIbook?
Currently, the ECNs appear ready to act merely as agents, offering a space where buyers and sellers can display and match their orders, and claiming a flat fee for each transaction as compensation for this service. This differs from Nasdaq, where market makers are self-interested and active participants, committing their own capital to sell stock at the ask and buy it at the bid. Yet, this means that each ECN wants the transaction to occur on its own turf. So while the ECNs may find it easy to negotiate order display transparency, they may have a tougher time negotiating a fee system to make for a wholly integrated market.
Still, this new pact represents another step in the ongoing evolution of our financial markets. And it's one that should help make after-hours trading a little more attractive to investors, who have so far greeted the extended trading day with something of a yawn.