CBOT’s journey to hybrid trading system might be guide to NYSE

There's a heated debate about the value of open outcry vs. electronic trading, with members on both sides of the issue claiming often — and loudly — that their view is the right one for investors and the U.S. financial system.

No, it's not the New York Stock Exchange. It's the Chicago Board of Trade, circa the mid-1990s.

At that time, some of the CBOT's management wanted to move forward with electronic trading but many members, sensing the possible end to their livelihoods, vowed a fight to the finish. Nevertheless, the exchange gradually introduced more electronic trading features, reaching the point that today, fully 80% of the CBOT's financial futures are traded electronically.

The CBOT's path to blending open-outcry and electronic trading might hold some lessons for the New York Stock Exchange and the traders who do business there, particularly with the current turmoil over specialist trading firms now facing the Big Board.

"We don't really have a specialist system," said Bob Ray, senior vice president of business development at the CBOT. "Everyone who's a member, a customer or market maker has equal access to every bid and offer."

At the NYSE, specialists are responsible for bringing buyers and sellers together, providing liquidity and improving prices. Several are under investigation by the exchange and the Securities and Exchange Commission for allegedly stepping between buyers and sellers unnecessarily as well as trading for their own accounts before facilitating customer orders.

The investigation into specialist activity has led some institutional investors as well as some electronic trading companies to call for an end to the specialist system.

"Does the Big Board survive? I think they do," Mr. Ray said. "But I think the role of the specialist will change."

At the CBOT, which trades products ranging from soybean futures to Treasury note futures and options, the move toward electronic trading began in 1994 with a program called Project A, which allowed electronic trading for a few hours after the close of regular pit trading.

"Project A was a homegrown system, a method that allowed us to provide access to our markets not only globally but also for more hours," said Jeffrey Hersh, the CBOT's director of project management.

"We were looking at the competitive landscape and we thought Project A was a good system to establish a toe-hold to make electronic trading available for customers who chose that," Mr. Hersh said.

Mr. Hersh said despite the success of Project A, the CBOT went to other electronic trading platform vendors to determine whether it would be better to continue to build its own electronic platform or not.

"We wanted to find out if there was something out there that could be enhanced and change and do what we needed or was it something we could do with Project A," he said. "The Board of Trade wanted to have an electronic trading system going forward and we weighed the pros and cons (of using Project A) vs. other systems."

In 2000, the CBOT launched a new electronic trading platform with its partner Eurex AG, Frankfurt, Germany, and on July 24, 2002, daily electronic trading volume topped 1 million contracts for the first time.

Mr. Ray said that despite that milestone last year, the CBOT began a search in mid-2002 to find a vendor to build the exchange's next generation electronic trading platform. He said the CBOT was looking to improve functionality, speed and capacity.

The CBOT considered Eurex for the project, but early this year, the exchange announced it would use the LIFFE CONNECT electronic trading platform for its system. LIFFE CONNECT was created by Euronext.liffe, London, an organization formed by the combination of the derivatives business of the Amsterdam, Brussels, London, Lisbon and Paris derivatives markets.

CBOT officials have said LIFFE CONNECT will enhance the exchange's competitive position by providing improved reliability, liquidity and flexibility.

"We're committed to an integrated approach whereby we have both manual trading and electronic trading. and we're going to provide both of these with the best capability we can," Mr. Ray said.

The new platform, dubbed eCBOT, is scheduled to launch Nov. 23 with trading on Dow Jones industrial average futures and options, mini-size Dow futures and options, and several other financial futures and options. The program will expand on Jan. 2 to include trading on Treasury and agricultural products.

Despite the exchange's success with electronic trading so far, the move to eCBOT is not without risks.

Eurex, already the world's largest derivatives exchange, announced plans this year to launch its own U.S. futures exchange, based in Chicago. Last month, shareholders of the Clearing Corp., the Chicago-based company that guarantees trades, voted to sell a 15% stake in the company to Eurex, allowing it to clear its own trades there. But to move forward, Eurex must receive approval from the Commodity Futures Trading Commission. Eurex hopes to launch its U.S. exchange in February.

Eurex has also sued both the CBOT and the Chicago Mercantile Exchange, alleging antitrust violations in an effort to block the Clearing Corp. deal, but the exchanges have denied the allegations and on Nov. 3 filed a motion to have the suit dismissed.

On Nov. 6, the U.S. House Committee on Agriculture held hearings regarding Eurex's application to be designated a market. At the hearing, Commodity Futures Trading Commission Chairman James E. Newsome said the agency, which regulates futures exchanges, would "review the application, mindful of all comments received, with an eye toward ensuring that all necessary standards are met, and that only sound, ethical business practices are allowed to exist in the U.S. marketplace."

The New York Stock Exchange has not let technology pass it by. In fact, most stockbrokers on the floor of the exchange have handheld computers slung over their shoulders that allow them to communicate with their firms and in some cases directly with clients as they work buy and sell orders.

Still, the exchange is faced with growing criticism over the whether its specialist system has fundamental conflicts of interest that put specialists' interests ahead of customers' and thus should be scrapped altogether or at least drastically modified.

A spokeswoman for the NYSE declined to discuss specifically how the exchange might learn from the CBOT's progression toward electronic trading but said in a statement: "The NYSE marketplace blends the best aspects of automation and a floor-based auction market to offer customers the NYSE's broad range of multiple execution options. We're constantly evaluating our competitive offerings with an eye toward serving our customers' diverse needs."