Trading technology may change quickly if plans to switch the Nasdaq to a central, limit-order book system are approved by the SEC, according to institutional equity traders.
Traders agree with a study done by Meridien Research Inc., Newton, Mass., which concludes that if the Securities and Exchange Commission approves the creation of a Nasdaq "supermontage" system, it might bury some of the existing electronic communication networks, or ECNs.
According to a spokesman for the National Association of Securities Dealers Inc., Washington, officials are two to three weeks away from filing with the SEC to gain approval of just such a listing system.
The new way of listing trades would not only give traders a list of the best executed orders on a particular stock, as the Nasdaq now does, but also would list other orders that have been placed during the day. This is a similar listing available to traders using ECNs.
The demand for getting additional trading information is part of what has propelled ECNs into the spotlight, alongside the idea of trading anonymously with additional liquidity.
The NASD spokesman declined to speculate on the future of ECNs, but did say the system the NASD is proposing is likely to change after the SEC makes recommendations.
"A central location (for directing trades) becomes virtual in this new world," said Harold Bradley, senior vice president and portfolio manager at American Century Investments, Kansas City, Mo.
He agrees with the Meridien study that the nine ECNs in use now aren't all needed. But he believes the two ECNs in which his company has invested will survive because they are intent on becoming established exchanges.
Chicago-based Archipelago and London-based Tradepoint Financial Networks PLC are the two crown jewels in American Century's bet on the future of trading.
Archipelago is an ECN that is partially owned by Goldman Sachs Group Inc., E*Trade Group Inc., Instinet Corp. and J.P. Morgan & Co. Inc. The ECN also is one of the members of a consortium that has a 54% stake in Tradepoint.
Other members of the Tradepoint consortium are J.P. Morgan, American Century, Instinet Corp., Morgan Stanley Dean Witter & Co. and Warburg Dillon Read LLC.
Instinet's investment is part of an effort to expand its grip on the global agency brokerage business, where the company has focused its attention rather than simply in its role as an ECN.
The intent of Archipelago to become an established exchange, and the consortium members using the system are part of the proof that Archipelago has the best chance of surviving, Mr. Bradley said. "There's a lot of business that flows through that venue (Archipelago)," he added.
But Archipelago ranks fourth in the Meridien study in terms of trade volume so far in 1999.
The ranking of the nine ECNs by trade volume is: Instinet, 48.8% of the market; Island, 19.5%; TradeBook, 11.4%; Archipelago, 8.1%; REDIBook, 5.9%; BRUT, 3.6%; Strike, 2%; Attain, 0.4%; and NexTrade, 0.3%.
By 2001, Meridien projected, more than half of the Nasdaq trading volume will be matched within ECNs, bypassing traditional Nasdaq market makers.
This would be a phenomenal increase, because ECN trades accounted for less than 10% of all Nasdaq trades in 1995.
The research firm ranked Archipelago third in terms of survivability in the next 12 to 18 months, with Instinet and Island leading the pack. "In the foreseeable future, it is extremely difficult to imagine the top two ECNs being seriously challenged," the report said.
Researchers said the main complaint against Archipelago was that the trading platform needs to attract more order flow beyond its core ownership.
Weaknesses of some of the other systems cited in the study were lack of liquidity and connectivity, especially in the cases of NexTrade and Attain, which are relatively new.
"If Nasdaq were to move to a fully automated, order-driven market -- in essence operating like ECNs currently do -- any need for ECNs would evaporate. Such a Nasdaq super-ECN would harness so much liquidity that other, smaller ECNs would find it impossible to compete," the report said. The researchers at Meridien decline to predict when this would happen.
While the Meridien study forecasts the demise of ECNs, Michael Franckowiak, managing director and equity trader at New York-based INVESCO, said there still will be a need for them.
He believes a couple of ECNs will remain in the marketplace, because there will continue to be a need for competition.
In doing his own informal survey of traders, Mr. Franckowiak predicts Instinet, which has a long history, and Island will be the surviving ECNs.
INVESCO uses ECNs to execute only a small portion of trades.
"We like to maintain a relationship with brokers because they offer analysis and information in return," Mr. Franckowiak said.
American Century's Mr. Bradley contends that what market makers offer might not be as helpful as some investors think.
"If a specialist gives you info about someone else, who's to say they aren't giving your (trading) info to someone," Mr. Bradley said. According to Mr. Bradley, this is why anonymity is so useful for ECN users.
For George Bodine, director of trading at New York-based General Motors Investment Management Corp., using brokers also offers the comfort of talking with a person and allows him to figure out more quickly whether there is liquidity in a certain stock.
Mr. Bodine believes the survival of ECNs depends on whether an intermediary will be put in by Nasdaq to facilitate transactions.
If the Nasdaq system does not require an intermediary and the public has direct access to the market as some do now through ECNs, the Meridien survey is right, he said.
General Motors directs approximately 15% of its trades through ECNs.
Usually, traders at GMIMCo use ECNs to execute value stock transactions with a smaller order flow, he said.