Just four years into their existence, electronic communications networks already handle one-third of over-the-counter U.S. equity market trading volume.
In a survey conducted in December and January, consultant Greenwich Associates, Greenwich, Conn., found that 73% of 300 U.S. buy-side institutions queried used alternative trading systems for Nasdaq equity trades, and 68% used an alternative for listed equity trades. However, only 16% of the 300 respondents' Nasdaq trades and 10% of listed trades were conducted through alternative trading systems. Greenwich, which surveys buy-side institutions annually, expects the percentages to increase in 2001, said John Colon, managing director.
The anonymity and liquidity institutions seek is starting to be realized, he said. The fact that investors are already paying commissions to brokers is preventing an explosion in ECN popularity among institutional investors. Even though trading through ECNs is cheaper, the ECN does not provide the research services brokers provide, he said.
But that 10% number is "slowly but surely rising," said Damon Kovelsky, an analyst at Meridien Research Inc., a Newton, Mass.-based firm that advises financial services firms on technology.
In the second quarter, according to Meridien, 33% to 34% of over-the-counter U.S. equities were traded on ECNs, representing a five percentage point increase from the second quarter of 1999. ECNs, which execute online trading, were invented to combat market-making problems of the 1990s.
Meridien's report, titled "ECNS 3: Are We There Yet?" shows that competition among ECNs is tighter than it was two years ago.
Reuters Group PLC's Instine, has the biggest share with 31% of the ECN market, but that's down from 49% two years ago, according to the new Meridien study. The drop is due largely to the growth of the ECN market, rather than lost business, said Mr. Kovelsky.
Instinet officials did not respond to inquiries regarding the Meridien report before press time.
Island held onto to the No. 2 spot with 28% of the market this year, up from 20% in 1999, while Bloomberg Tradebook saw its market share slip one percentage point to 10%.
ECNs that held small percentages of the trading volume in the 1999 study have made substantial progress as well: REDIBook has 14%; Archipelago, 9%; BRUT, 7%; and NexTrade, 1%.
Island, a spinoff from Datek Online Financial Services LLC, has 700 broker-dealer subscribers.
"The key is the speed and the reliability," said Andrew Goldman, executive vice president of Island. He thinks the ECN has been successful because of advanced technology and the ability to execute large trades quickly. "Liquidity begets liquidity."
He estimated Island's current daily trading volume at 300 million shares. Although that's lower than its springtime daily average of 375 million, Mr. Goldman said, the total should rise again when trading activity increases in late summer. In addition, he estimated, 20% of trading of the Nasdaq QQQ stocks, the index of 100 stocks that track the status of the whole market, are traded by Island.
Island applied to the Securities and Exchange Commission to become a for-profit exchange in 1999, but a decision has yet to be delivered. Until one is, Mr. Goldman said, Island will continue to build its "core Nasdaq business."
Mr. Kovelsky expects some of the smaller ECNs to disappear. Strike, which had 2% of the ECN trading volume in 1999, has already ceased to exist.
Island has not ruled out the possibility of acquiring its smaller counterparts, but the firm has no intention of targeting small ECNs right now, Mr. Goldman said.
The retail market, which has kept smaller ECNs alive beyond startup status, eventually will drift toward larger ECNs, said Minder Cheng, global head of equity trading for Barclays Global Investors. He believes the expanded coverage of a large ECN will appeal to retail clients.
BGI uses ECNs for trading whenever possible, he said. It uses Instinet, where the majority of their ECN trades occur; ITG; and REDIBook.