P&I Round Table: The best-execution challenge

Achieving best execution for large institutional orders involves a lot more than just looking for the best price on various markets — it’s a process, according to six industry experts gathered at Pensions & Investments’ trading round table in New York on Feb. 6.

This search for best execution is even more daunting when markets are volatile or if the portfolio to be traded includes low-liquidity stocks and securities in exotic markets. For special cases, experts agree that patience is a virtue, as a good trading strategy can, by keeping explicit and implicit trading costs down, enhance a portfolio strategy’s return.

Electronic trading has led to the development of an array of different execution venues and market models, which can be confusing to even the most seasoned institutional trader. But the choice of trading places is a great asset to avoid or at least limit market impact and tailor execution strategies according to changing market conditions.

In addition, as markets become more complex, brokers often take on an educational role with their institutional clients. Experts say that over the past couple years, those customers have developed a real desire to better understand trading and even to venture into new areas such as using equity index futures to hedge positions or gain exposure.

Participants were: Tal Cohen, senior vice president, Instinet LLC, New York; Ian Domowitz, managing director analytical products, ITG Inc., New York; Brian Hyndman, senior vice president transaction services, Nasdaq Stock Market Inc., New York; Timothy Misik, head of institutional equity trading, Northern Trust Global Investments, New York; Scot Warren, managing director equity products, CME Group Inc., Chicago; and Kyle Zasky, managing director EdgeTrade LLC, Knight Capital Group Inc., Jersey City, N.J. Isabelle Clary, senior reporter with Pensions & Investments in New York, was moderator.

What follows is an edited transcript of the roundtable. An abridged podcast version also is available at pionline.com/podcast.

Ms. Clary: Good morning.

Tim, if you don’t mind, I would like to ask you the first question. Since you are responsible for a very large portfolio, what does “best execution” really mean when it comes to trading your large global portfolio, and what are the trading tools you need to efficiently trade that portfolio?

Mr. Misik: Well, I think the best execution for a large global portfolio is kind of the same for any portfolio. It’s imperative that we achieve our client objectives, while we fulfill our fiduciary responsibilities, our regulatory and ethical responsibilities, and our firm objectives as well. Our client objectives always entail low-cost, low-impact trading as the primary objective, regardless of size or countries or anything in the portfolio. …

Ms. Clary: Have you found some particularly challenging situations in recent weeks where we have witnessed huge market swings around the globe?

Mr. Misik: We’ve had some single-country transitions that have been right in the midst of these 2% and 3% daily swings where we’re one-sided in some instances. Preferably, we get two-sided so we can balance out our risk, but lately we’ve had some one-sided transitions where it’s been very difficult.

Ms. Clary: Scot?

Mr. Warren: I think what Tim is describing is something very consistent with what we talk to our institutional clients about: describing best execution as a process, not an individual order component. Certainly, you’ll look at aggregate results of your individual orders, but you’ve got a process in place to look at markets and think about impact costs in achieving clients’ objectives over a longer time horizon than merely the last order.

Ms. Clary: Anybody else want to jump in on that elusive concept of best execution in volatile markets?

Mr. Zasky: I definitely agree with Scot. It’s definitely a process. It’s beyond just how you perform on that particular trade. You know, (for) some people speed is more important; some people, price is more important. But, overall, you have to evaluate what you’re doing as a fiduciary for the money that you’re investing and make sure that you have the ability not just to have a process in place, but be able to demonstrate that to the regulators.

Ms. Clary: Tim, do you find yourself, sometimes in the situation where even though the strategy would entail selling or buying some securities, you just feel that the market conditions are such that it’s better just to step back and wait?

Mr. Misik: (T)hat’s actually a very good point, especially in these times where volatility across the globe is spiking. We’ve actually consulted clients and suggested, and encouraged them strongly, let’s say, to step out of doing a particular investment or a transition into a type of asset class … and wait until the volatility does calm down. And we’ve been successful in doing so. It really becomes a client education process, because by the time the order actually hits our desk, if the order gets to our desk, we generally have to get it done. We’re tightly constrained from a performance perspective, from an investment perspective. So if it gets to the trading desk, we need to be done with it. So we try to be ahead of that curve. Say we know a transition is coming. We need to step back. Advise our clients, educate them and, hopefully, successfully do so.

Ms. Clary: Ian, you wanted to make a comment about best execution in volatile markets?

Mr. Domowitz: No. It’s beyond just volatile markets. I think that as we talk about process, one thing that I’ve noticed — because it’s true, everyone agrees that best execution is in some sense a process, not a price — what I’ve observed, though, is that there’s a temptation to extend the notion of that process well beyond best execution in the sense of the trade.

In other words, we now talk, and some ways very successfully, about how these costs can be taken into account at the portfolio level, but we risk a bit of confusion, dilution of the concept. If you sort of try to make best execution, you know, a process starting at the stock picking level all the way through to clearance and settlement, now we’ve got a little bit of a problem on the one hand. On the other hand, that, indeed, is supposed to be the total solution.

So I think definitionally, we’re more or less on the same page, but the page seems to get bigger all the time.

Ms. Clary: That’s a great concept. Does that come from the sell side or does that come from your clients?

Mr. Domowitz: It’s from the buy-side clients, all right. This situation may be changing in Europe, of course, given changes in regulatory regime, but right now, I’d say it's driven by the buy side in two ways: on the portfolio side, the way the portfolios are actually managed relative to the transactions cost expected; and on the back-office side, there’s a growing realization that if your idea of best execution is, for example, to direct your orders to a lot of different places, all of a sudden your ticket charges start to rise, so your total cost of trading is now increasing. And as we look at that, you may, indeed, be eliminating the benefits you get from a best-execution strategy at the level of the trade.

Both of those are driven at the level of either the buy-side portfolio management function or the trading desk side.

Mr. Misik: And to the extent — to follow Ian’s comments earlier — to the extent that we start including those processes outside of “just the execution,” whether it's clearing or settlement or operationally, there is risk in operational issues.

There is significant risk globally in not getting things settled. … Those become real money charges to real clients, and you lose business as a firm over those types of issues. I agree with not broadening that best execution definition too widely, but at the same time, you know, those are real money numbers that come through in those situations, if they go wrong.

Ms. Clary: So would you say there is a point where there is a balance between the quest for best execution in multiple places and the cost efficiency of trading those positions?

Mr. Misik: Absolutely. I think they go hand in hand.

Ms. Clary: But to find that point seems to be more of an art than a science.

Mr. Misik: Which is why I refer to it as a process as opposed to a quantified measure on a given trade or on a given set of trades.

Ms. Clary: Brian, in those markets where you have a fully transparent open book, like Nasdaq, if I am an investor, at least I have two benefits; I have transparency and liquidity. How important are those two benefits when you are in extremely volatile markets? Does that trump having large orders sitting in the dark book where the market can suddenly turn against you?

Mr. Hyndman: I think in extremely volatile markets, if you’re trading in the public markets, you get the transparency. You know what price you’re going to get. You know that you can get a trade done rather than having, you know, a limit order sit in a dark pool, not knowing if that’s ever going to get executed, if the market’s going to run away from you.

So I think public markets and dark pools both bring great benefits to the end trader. Clearly, I think there’s the ability for both of them to co-exist, and you know, I don’t think that you can just trade on one and not the other.

Ms. Clary: So would you say that, by nature, the dark pool is more the place where you have the great advantage of reducing information leakage, when you are in a fairly smooth market, … but when you are in those markets where you don’t know where the markets will be in the next five minutes, that at that stage, the open books are more suited for active trading in active market conditions?

Mr. Hyndman: No doubt about it. The dark pools clearly limit the market impact on trading. But in volatile markets, the stats that we see are that the public exchange volumes skyrocket, and the dark pools and the internalization engines out there stay somewhat static in their absolute volume.

Ms. Clary: Tal, since you have a lot of both dark books and open books around the world, what has been your experience in terms of that best execution for some of your customers who have positions in the main markets around the world?

Mr. Cohen: From looking at the multiple regions we do business in, the regulatory frameworks drive a lot of the interpretation in a practical sense. In some cases, the regulators do not differentiate between best price and best execution. In some cases, they do. And what that does is it really drives technology implementation of market structure in many regions. So you look at Europe and you look at Asia, you look at the U.S., and you actually separate the U.S. from Canada, and they have different interpretations of best execution. So while it’s a process, what drives a lot of it is the regulatory framework and rules and regulations. Do they make a differentiation between best price and best execution? Who’s the obligation on? Questions like that, I think, drive and make it more complicated to execute a global portfolio, because what best execution is under MiFID (the Markets in Financial Instruments Directive) may be different than under UMIR (Universal Market Integrity Rules), which drives Canadian regulation.

Then going back to operating dark pools vs. display markets, I think what we recognize is it’s important to have choice, and if you have different market models that meet different needs, different problems that you see arise in each of these markets, then you’re well situated to provide your customer … with an opportunity to choose between “should I post an order on a dark pool, should I actually then have that dark pool send it to a display market, or should I just control that myself in terms of where I display that order and what I do with that order?” …

(I)t’s stereotypical to say dark pools are better at limiting market impact, because if a dark pool is owned by a particular broker and has some composition of order flow, and the constituents in that dark pool some may consider more toxic than others, then would you really want to be in that dark pool? So on the surface, I think it’s difficult to say dark pools mitigate market impact. But … what you want to do is provide your customer with choice, the ability to have flexibility in how we interact with the dark pools and the display markets.

Ms. Clary: Well, you made a very good point, which is best execution is not only a process, but it’s a concept that changes from country to country, depending on the regulator’s approach. Of course, your customer might not be totally aware of every single regulatory wrinkle that may have influenced your decision as the executing broker to work an order one way or another. Do you think that because of the market situation we have seen recently, your customers get more involved in trying to find out why an order was worked one way or another?

Mr. Cohen: Yes. And what we often say — and now it’s just highlighted in the volatile times that we live in, but what we actually sell to our customers, and I think many brokers sell the same thing — is, we don’t want to expose you to nuances or idiosyncrasies in each market. It’s incumbent on the broker to become an expert on market structure, rules and regulations, and essentially what trading strategies work in these various markets. So, generally, you do not want to expose that to your customer. And, generally, you want to make sure that your customer knows it’s incumbent on you to have that expertise. If they want to consult with you on that, then that’s very helpful. But in times like this, yes, you do see a lot of customers pull back, take control and empower themselves, because, generally speaking, the unknown or anything that’s ambiguous, tends to introduce friction cost and is a problematic situation not only for the broker, but the client.

Ms. Clary: And by the end of the day — I mean, we have seen days where Hong Kong was down 10%, (then) up 10% the next day — what is the client’s reaction? Is it: Why do I have such a large bill in terms of execution costs? Or is it: Are you sure you really manage to get the best price in those difficult market conditions?

Mr. Cohen: What we try to do is manage expectations up front and understand what the client’s objectives are prior to him or her entering that order into the marketplace. And, once again, (it) is incumbent on brokers to explain their execution capabilities within each of these regions. So, for instance, if you’re looking to trade a global portfolio across different regions and multiple markets, you want to be very clear with your customer what your capabilities are and what you’re potentially exposing the customer (to) as he enters into those different markets.

Ms. Clary: Kyle, I’m sure you have something to say.

Mr. Zasky: I think … the sell side has a value proposition to the buy side, and part of that really is how to handle the orders, how to communicate to the buy side what their skill set is, how they interact with the markets. Essentially, I don’t think that there’s one particular method — whether it’s electronic or high touch, whether it’s dark books or public display markets — that you can absolutely say is the best process for a particular client or particular order. That’s why it’s always an ongoing education process between the buy side and the sell side, so that everyone can be on the same page, and expectation management (process), so that during volatile times or times when the market’s not so volatile, the buy side can rely on the sell side to provide them with something that they’re comfortable with, and the buy side’s responsibility is to evaluate the providers out there and give orders to the companies that they feel comfortable (with).

Ms. Clary: So it’s based on a certain notion of trust?

Mr. Zasky: You know, Wall Street has been based on trust. I mean, just the idea that you can buy hundreds of millions of dollars worth of stock and hope that someone pays for it in three days. There’s an inherent element of trust that goes on in trading stocks, and essentially in any business. You want to do business with people that have a strong reputation. People that you can rely upon, particularly when things are volatile. If you’re going to make a call to someone to handle an order for you, you want to take a look at the experience you’ve had with them over the past couple weeks, couple months or couple years, and those are the people that are going to get the call, if it’s on the high-touch side, in the future, and the electronic providers are the ones that are going to get the orders in their system.

Ms. Clary: When you are in difficult market conditions, do you see clients saying, “OK, I know that firm has taken good care of me in the past in a difficult market. Instead of spreading my orders over a great number of brokers, I am going to really send my orders to the guys who have a proven track record of doing well when the going gets rough”?

Mr. Zasky: Yeah. I think there’s actually two parts to that question. The first part that I want to address is it’s not just during volatile markets, because even during calm markets, there are a lot of securities that don’t trade very frequently, that are difficult to get done. In those circumstances, it doesn’t make a difference how good your dark book is. … It doesn’t make a difference, you know, what kind of connectivity you have algorithmically. Ultimately, you might want to rely on a high-touch salesperson who can help you get that order done. And coming from me, who’s been a champion for years for electronic trading, not the high-touch business, you have to sort of say that I’m viewing this very objectively, that there’s circumstances where human intervention is the best to get the order done. The second part of that question — what was the second part of that question?

Ms. Clary: The second part of the question was the human angle to that volatile market situation where you feel, “I’m going to trust the guy that I know can really work well in hard conditions.”

Mr. Zasky: Absolutely. And there’s a couple of prongs to that. There’s the trust part of it, which is extremely important. Then there’s the tools that the sales side is providing the buy side. And then there are certain companies that specialize in things that other companies don’t. You know, some companies have access to liquidity that other companies don’t, and that’s just sort of a reality of the competitive environment. For a particular trade, you might … want to use Instinet for a particular trade; you want to go to ITG for, you know, a small-cap or a midcap stock; you definitely might want to go to Knight Capital Markets. And so every trade is different, and that’s why the buy side has to have a network of sell-side providers that it can rely on for each particular circumstance.

Mr. Misik: Isabelle, if I can add to that. I think that the communication aspect of it is paramount here. Because in those volatile markets, in those difficult trades, in those times, you do have to go to the person who knows you, as well as your client base and your risk tolerances, best. …

(I)f you’re working with a group of people that you communicate well with, that you strategize well with, that you agree philosophically with — and you’ve had that experience in less volatile times on easier trades — you’re going to be more inclined to go with that person that you trust, but also, that you know and understand that strategy ahead of time.

I don’t have to spend five minutes explaining how I want a trade worked into the close. They understand how I want a trade worked into the close. They’ll understand my risk tolerances and my parameters, and we can just move forward from there.

Ms. Clary: A follow-up question for Scot. Bad things happen to good markets, and sometimes you have one specific event that is really not related to any particular positions. … (M)arket behavior is such that (while) you thought you could just hold on to your positions, something happens that has nothing to do with your positions, and the next day you have to make a quick decision.

So just to go to an example that I’m sure everybody has heard of, when Société Generale started dumping a lot of contracts, equity contracts which were not CME-listed contracts, but obviously the world market could see this huge volume of index products being dumped from Asia to Europe, what was the impact of that specific event on your market?

Mr. Warren: I think it’s dangerous to speculate if Société Generale was actually the driver of that market move at that point in time. …

(I)n a global crisis, correlation approaches one on all products; it’s going down. Then it becomes what’s the liquidity center have available with a heterogeneous pool of participants and the ability to have a two-sided market that's displayed, transparent and actionable, that allows people to change the beta characteristics of their portfolio.

And so, in any period of increased volatility or market uncertainty, we see an absolute increase in volume, because we have a deep liquid pool and the ability to change the beta characteristics or the risk characteristics of your portfolio. It’s a flight to quality, if you will, just as many people in times of crisis will lean on Treasury securities, using the S&P 500, the Nasdaq or the Dow, to change the beta characteristic of their portfolio … and they come to our market center because they see a price and it’s actionable, and that provides certainty.

Ms. Clary: So you would say in terms of crisis contention, go to where the liquidity is?

Mr. Warren: Go to where displayed liquidity is, where you’ve got certainty of execution, because I think — back to many of the things that we talked about before — there’s a trade-off between certainty and impact. If I can see a displayed price and I’m certain of execution, I need to at least participate in that market. Because I can wait and hope things get better or I can work and take advantage of liquidity that’s out there presently.

Mr. Hyndman: We actually have some statistics at Nasdaq that when the markets get extremely volatile — even though Nasdaq is somewhere south of 50% market share in Nasdaq-listed securities — on highly volatile days, because of our technology and the certainty of execution, our market share spikes on those days, and it goes away from the smaller fringe players to the liquidity center where they’re going to have a certainty of execution.

Ms. Clary: Have you noticed that kind of behavior, Tim?

Mr. Misik: Well, I have, and I think that is maybe a result — and Brian, you can probably speak better to this — but as a result of wanting to going directly to the market center instead of using electronic means to maybe go to the market center … You don’t want to play with time lags, because I’m a proponent of implementation shortfall. Even in very volatile, very short time frames, you want to reduce your opportunity costs, i.e. if you have a trending, volatile market, you don’t want to be exposed to that for any period of time.

Mr. Warren: I think Tim and Brian have also pointed out the structural advantage. It’s the transparency of pricing and liquidity at the book, but it’s also the scalability of the infrastructure to handle the peak capacity days. And I think that’s where market centers differentiate themselves in that scalable capacity, and combining the scale that they have, the transparency of prices, the liquidity on the books to give people the confidence to act.

Ms. Clary: OK. Well, Tal, there has been a new development on the global scale, the introduction of MiFID in Europe in November. So, to me, it’s a little bit like the ECN (electronic communication networks) revisited in the late ’90s in the U.S. What is your customers’ response going from countries where it was very simple, there was one market, to having this competition?

Mr. Cohen: It’s a good analogy to look at 1997 when the handling rules (changed), which was the catalyst and the impetus for the introduction of Instinet, Island, shortly there afterwards Arca, and essentially, a proliferation of alternative venues. So changes or reforms in market structure generally are amplified by two things. One is technology; the reform itself generally doesn’t drive change, but is amplified by the fact that technology and regulation sort of have combined or there’s a confluence of events where you can now take advantage of that change.

So what you’re seeing in Europe, and actually, it’s happened across the globe … MiFID (has) introduced competition or promotes competition in many ways. What you need to be certain of is that you can introduce a market model that is different from what they (clients) have, because if you provide them with a market model that’s essentially a replica of what’s already out there, then you’re really not taking advantage of the regulatory reforms. So what’s inherent in … and underpins the assumption of alternative market centers is that they have different business models, and that they invite competition, and that they engender innovation.

What they also allow you to do, at a very tactical level, is if you’re a buy-side institution that has implemented trading strategies in one particular market, now you can consider porting those strategies to other markets where these venues, these alternative market venues, have now proliferated. Because, once again, the underpinning assumption is these market centers — these alternatives — often replicate what’s in the U.S. or elsewhere in the globe.

So if you’re sitting there on the buy side and you’re thinking, “Well, what does this mean to me? What does it mean to have an additional market center out in Europe? Out in Asia? In Canada?” Well, it means a couple things. One is, potentially, it lowers your trading cost. Two is it provides you with some consistency in the way you trade. It’s predictable. The market center acts and offers you features that you’re used to — used to interacting with. Then, once again, you can port trading strategies over across markets, which lowers the cost of entrance into a particular market in many cases.

So you look at regulatory reform, and it starts there, but it certainly doesn’t end there.

Mr. Domowitz: I think a lot of that is absolutely correct.

I think I would disagree a little bit with your opening, Isabelle, in the sense that I don’t think this is like the United States and ECNs. … In the mid-’90s, several things were going on. I mean, largely, we were looking at the incursion of ECNs largely as a result of a regulatory shift — the order handling rules — and of inefficiencies in the existing over-the-counter market. It was very costly to trade. As electronic trading came into play, there was another factor, and that was simply the cost of building a market center. You know, it dropped dramatically in the electronic era. So, that all came into play.

Trading costs have been low in Europe for a long time. The issues there have not typically been around that notion of efficiency, (but) rather with a monopoly position of exchanges, and issues of clearance and settlement. So there, it is almost competition policy and principles-based regulation that has led to the change. And, frankly, we’re just now seeing the scramble. It’s very early days, you know, for both trade reporting and execution. But in Europe, you see the fight that … developed largely during the regulatory process, and now it gets to be played out via implementation. … It wasn’t a question of exchange vs. exchange or even broker vs. broker. Now, it’s broker vs. exchange when it comes to competition — or the competitive landscape, let’s say — in Europe.

And I think that at a macro level, from the point of view of running the business of an exchange, of a market center, it’s these macro principles that really come into play. The notion that we will all provide the right kind of technology for the time, I think, is virtually taken for granted, and perhaps that was part of Tal’s point. I mean, these days, technology, if anything, serves as the legal safe harbor for regulation. Especially from an execution regulation (standpoint) because you can track everything. … You provide all this variety for best execution. All the audit trails you need, etc., etc. I mean, it truly provides a safe harbor. And in that sense, I would agree, it’s tied very closely together with the regulatory environment. But the things that are driving MTFs (multilateral trading facilities) in Europe are driven not only by regulatory principles, but also by the way in which the competitive environment has been changed by those regulatory principles, and that is the macro view.

Ms. Clary: How do you think the institutional clients are viewing that change in Europe? Does it make their life easier? Better? More difficult?

Mr. Domowitz: I’m very fond of saying that as a firm, our business is largely to manage change on behalf of our client, and I think that is more true than ever here. They certainly are looking to the sell side to figure it out, right? Some of which they cannot do, right?

In other words, there are some regulatory changes they actually have to absorb themselves. But, largely, they’re saying, “Well, it’s your guys’ problem. You know, we’re in the business of making money based on our portfolio decisions. Can you please help us out?”

Mr. Hyndman: I think it creates a great opportunity for the sell side and the brokers, much like it did here in the U.S. Whether it was the order handling rules or Reg NMS that fragmented the market, that created a great opportunity for the brokers and their algos to solve a lot of the issues for the buy side.

The same thing is happening over in the European markets, just to a lesser extent at this point. You’re going to see the fragmentation pace pick up later and, again, that’s going to create a great opportunity for the brokers and their algos. They’re going to say, “Send me your order. I’ll solve your problem. I’ll make sure I get you best execution. I’ll ping. I’ll probe. I’ll route. I’ll do everything that you don’t want to build and do, but you’re obviously going to pay me a nice fee. But I got the technology. I did it over in the States. I’m going to do it over here.” So I think it’s a great opportunity for the brokers.

Ms. Clary: Tal?

Mr. Cohen: They’re making good points, and there’s two things that generally occur.

One is, typically, something outpaces something else — either regulation outpaces technology or technology outpaces regulation — and it causes some pain in the beginning.

So with MiFID — as Ian noted before, and maybe this is what you were saying before also —there isn’t a big bang. … We didn’t expect a big bang with MiFID, but some people did. And what they did because of that is they made investment decisions. They made investment decisions because they said, “Nov. 1 is a time line.” It’s very convenient to have time lines. We all like time lines because it holds people accountable. So that’s what we did. We said, “Here’s a time line for you. It’s Nov. 1.” And it was sort of a self-fulfilling prophecy that we need to be ready for Nov. 1. But what actually happened is, way before Nov. 1, this started playing out. Regulation came out, and regulation was a result partly of the Myners Report that came out in 2004-2005.

So very much like ’97, where the market makers were doing things they shouldn’t be doing and price discovery and transparency were an issue — I do agree with Ian that it’s not analogous completely, but there were issues in each of the different markets. Were those sort of confined to trading issues? No. From a paying European perspective, clearing is an issue. Clearing is definitely an issue from country to country. So there were multiple levels where you wanted to address those issues, but the starting point is that usually either regulation outpaces technology or technology outpaces the regulation. …

And, secondly, if you sit in a position where you can take advantage of it, the electronification of the market swings in your direction. In other words, (if) you’ve invested in product and technology, then you’re probably well positioned. If you haven’t made that investment for the last year and a half, you’re probably on the other side of the fence saying, “I’m not sure this is good. I’m not sure this makes a lot of sense for us.” I don’t think that you wake up one morning and you look at it and say, “MiFID requires me to do the following” or “the market has changed overnight on me.” I think what you’ll see is those brokers who understood that it was incumbent on them and part of the value proposition to start looking at these things in 2004-2005 are now well positioned in 2007 to take advantage of that change.

Ms. Clary: OK. Ian, you made a very interesting point by mentioning the emerging competition between brokers and exchanges, which is a rather new development. We have two gentlemen from exchanges here. Scot?

Mr. Warren: Some of the consortium issues that you see in Europe are less about best execution for customers than a dialogue about ownership of market data and transaction fees. So much more (are) about economics between the broker community and the exchanges, rather than best execution. And I think it’s important to separate what’s best execution related vs. splitting economics.

Mr. Hyndman: So just so I’m clear on the question, it's basically —

Ms. Clary: I think that we see the result of the regulatory and technology changes, we see brokers and exchanges now kind of competing on each other’s turf.

Mr. Hyndman: That’s been going on for some time. You know, clearly, I would say over the past seven years or so, exchanges have been competing with brokers, and the example that I’d like to use is the limit order. You know, exchanges went directly after the limit order where the Knights and the other, you know, wholesalers, wanted those limit orders to come to them. But the way that it kind of ended up, for the most part, is that the market orders would go to the wholesalers and to the brokers, and the limit orders would come to the exchanges. So right then and there, there was competition. … Going forward, though, we’re clearly competing for executions. They have their dark pools — I like to call them internalization engines — and we have our public exchanges. We’re trying to get the flow first, they’re trying to get the flow first. There’s going to be a price dynamic that comes into play very soon there also. So not only was it limit orders, but now it’s actually who gets the execution first, the public exchange or the dark pool.

Ms. Clary: What does that mean for the institutional customer? Are they winning in that competition?

Mr. Hyndman: It’s more confusion for the institutional customer. The broker with the algo wins.

Mr. Cohen: But Scot brought up a really good point, and there’s a little history to the brokers and the exchanges and the competition there. There’s always been healthy tension there, but some of the history is that when many of these exchanges were privately held … the largest customers were the largest shareholder, so there was no dislocation. When these exchanges demutualized, all of a sudden the largest customers were no longer the largest shareholders. And they felt like, well, “How do we now monetize our merchandise? The exchange takes my market data (and) resells it, but it’s my market data. So how do I go about recapturing that asset and how do I monetize that asset?”

So Scot’s point is a very good one, and I think there’s an inherent dislocation now in many markets where you have a public exchange. They’re out there to optimize shareholder value and to be progressive about what they do, day in and day out — not to serve the needs of the few or a handful of constituents, which is what the big brokers would like them to do. So there’s always going to be that healthy tension. It’s existed for some time. It’s amplified in markets where the exchange is public, and I think it’s a healthy dislocation.

Mr. Warren: I also think it’s important to step back and ask as an exchange: What’s our job?

I’m a liquidity center and I need to aggregate liquidity from a heterogeneous pool of market participants. So I don’t just have retail trading with retail, I have a broad cross section of the market participating.

The other thing that really separates (us) — and is a line of demarcation — is the exchange doesn’t commit capital to the trade. So, essentially, we’re neutral, we’re Switzerland in the equation, and that in a large part, gives institutions … confidence the playing field’s more level. I trust it. There’s transparency of pricing. I know what the rules and expectations are. …

I’ve got a healthy tension now between the institution and the broker; they’re working as an agent, they’re also working as principal, how do I get that divide, and am I comfortable with the Chinese Walls and information barriers within the broker?

Ms. Clary: Tim, you are the client. I have heard some institutional clients saying, “Well, that’s good. It’s even more competition. I’m going to get better services at a better price by the end of the day.” Others feel like, “Well, now there are even more people competing for my execution dollars.”

Do you find that this new competition in terms of technology and services between brokers and exchanges is positive to you, or more confusing?

Mr. Misik: Well, it’s interesting, when we’re talking about clients and customers. I’ve always represented, for the large part of my career, a buy-side institution, which to me means I’m representing the end client, whether it’s mom and pop at the post office or whatever it is. To them, you know, it really doesn’t matter.

But there’s a number of customers here, right? There’s exchanges as customers. Broker/dealers are significant customers of the exchanges, as are we. So you have a number of competing ideals going on, and I’m not going to sit here and say my ideal is more important than anybody else’s.

But I think that’s why MiFID and other things are put into place, to protect that end customer who really can’t defend themselves technologically or in a regulatory sense. It makes things more confusing. It makes things more difficult, and I think Kyle brought up a great point. That’s why we have to rely on broker/dealers. That’s why we pay broker/dealers to represent us in the various markets to be experts on the legal changes, to be experts on technology changes and the ability to access various pools of liquidity, displayed or undisplayed. It definitely makes things more difficult.

But I think the competition is healthy. At the same exact time, it’s healthy and it’s necessary. I think in the end, it will reduce execution costs. It will benefit us as an end client eventually … and in current time as well. But … we’re slower to progress technologically than the exchanges and the broker/dealers, so it makes things more difficult for us. But that's why we have jobs and that’s why we’re employed.

Ms. Clary: Let’s talk about market fragmentation. Because we have this way of accessing all of those venues, the market that looks very fragmented is actually not fragmented at all because the smart guys can go everywhere and allow you to get the best execution for your order. Kyle, you created EdgeTrade with the goal of bringing that liquidity to your customers. What is your experience with all the new tools we have and that market fragmentation issue?

Mr. Zasky: You made a couple points which are important. There is fragmentation. Everybody knows that. But from the end-user perspective, even though you’re aware of this chaotic mess, there are a lot of providers out there that are in business … But what we do is … provide that value in terms of sourcing that liquidity and managing that confusion on your behalf to serve your needs. And there are a lot of companies that do that. I think that what our philosophy has been is that we can solve these problems through technology. There’s a regulatory world which dictates the framework that we can compete in, but ultimately, technology solves a lot of the issues that we’re talking about.

You know, I listen to Scot — I think you have that centralized book. There’s liquidity. There’s certainty. Those are very important points. But I don’t think that we have to have one centralized exchange that’s mandated by one regulatory body to accomplish that particular goal.

What we can do is, through technology, we can have the competitive environment, which creates innovation. But as long as both sides are talking to each other in a technical way, that empowers the end user, the buy side, where you get the best of both worlds.

We’ve got regulation that protects the retail investor. We’ve got regulation that protects the integrity of the marketplace for all participants. At the same time, we have innovation without that being squashed. I think a lot of the innovation that’s happened in the United States took place before the regulation. The regulation sort of followed the innovation. I think that happened in the ’90s with the ECNs. They did exist. There was an ECN essentially for a decade beforehand. And the regulators caught up with that in ’97 and actually just disclosed that as some sort of mandate. But the technology was really the driver of that evolution.

Ms. Clary: Brian, as an exchange, you are to some extent an aggregator of liquidity. If an order cannot find the match on the best price on your book, you have the mandate of sending that order to a place that does display the best price. So do you think that has changed the role of an exchange?

Mr. Hyndman: Yeah. I would say since the world has become fragmented, in order for an exchange to really be able to compete, it had to be able to build this routing functionality. So, obviously, we’ll give you the best execution that we can offer in our book, in our displayed transparent book. We also have a significant amount of non-displayed liquidity. About 20% of our liquidity on Nasdaq is non-displayed. But if we can’t offer best execution, then we obviously go outside of our book to all the other protected quotes here in the States. And if we didn’t offer that functionality, you know, we just wouldn’t be on a competitive level playing field with other ECNs that do offer that.

Ms. Clary: But, of course, as an exchange, you only probe other displayed books, regulated markets.

Mr. Hyndman: Right now, today, we only probe other … protected quotes. … In the future, though, that is going to change.

Ms. Clary: Kyle?

Mr. Zasky: Just in terms of the Nasdaq market, which is great at many things and has a lot of liquidity … I think that the dark liquidity that’s out there can’t be ignored. So where, you know, we have certain products that seek out liquidity in both the public markets and the dark market simultaneously — we’re seeing execution amounts over 30% … taking place in the dark. So if you’re a buy-side participant or a sell-side participant and you’re thinking that you can just rely on one particular exchange to get the job done for you — for example, Nasdaq — until you guys have some sort of routing technology out of your own market, no matter how large you are, you might not be servicing the client’s complete needs on that particular order at this point … in the evolution of this environment.

Mr. Hyndman: I think that's a fair statement. Right now … Nasdaq will obviously execute in its book and go out to all the other public markets, but there’s some changes where we could potentially be going to private markets in the future.

Ms. Clary: Ian?

Mr. Domowitz: I think there are two things I can add at this point. … The first goes back to the regulation and technology. You know, what came first sort of thing. Although I basically agree with you, Kyle, I think Tal had a point about them coming together. …

If you think back — although 1986 was a very big year in the sense that they received their no-action letter that actually allowed them to trade as an ECN — Instinet’s been in existence since 1969, and the first concept release from the Securities and Exchange Commission aimed at regulating electronic markets was in 1969. It followed immediately upon Instinet’s emergence as a company. It took four failed attempts to get to Reg ATS, but they were trying, right? They were trying; they were trying desperately. So, you know, the interplay was definitely there. It dates back quite a bit. And sometimes it’s hard with … how fast markets move to sort of maintain that kind of sense of history. But it is there nevertheless.

As far as the virtual consolidation is concerned, I think that there’s a data point to keep in mind. People have blamed a lot of things on Reg NMS. Whether it’s the rise of electronic markets, or the spending on infrastructure, or justifying just about anything anybody wanted to do in the last few years in the United States … you can trace it back to Reg NMS.

But my claim is that this routing function, this consolidation on a routing level, was already there. If we narrow in on the part of Reg NMS that’s relevant to this discussion, it all had to do in a sense with making, creating a consolidated top of book. … Now you think that that would cost money to do. But survey results tell us that, on the sell side anyway, I don’t know about the exchanges … survey results suggested that only about $92 million was being spent over a period of two years to actually make this happen. Now that may sound like a lot of money, but let’s put it in context. The annual commission pool for the United States is estimated at … approximately $13 billion; $45 million a year, $46 million a year is chicken feed, relative to that commission pool. So this consolidation was already complete. … In other words, very little remained to be done from the sell side point of view, and the regulations fundamentally applied to the sell side and the exchange. So we were already there.

Mr. Cohen: There’s actually one thing I would add to that … and you’re rightfully pointing to Reg NMS as sort of the scapegoat for a lot things, but what actually has happened over the last two years is routing’s always existed, but now what we’re seeing is co-opetition between brokers. So when brokers are taking on exchanges, they realize they don’t have the muscle to do it themselves, so they’ve created this social network of dark pools that sit behind the exchange, and all of a sudden, you have Morgan Stanley talking to Goldman Sachs, talking to UBS, talking to Merrill Lynch, talking to ITG, talking to Instinet.

Mr. Zasky: The MySpace of Wall Street.

Mr. Cohen: Yes. … It’s a Wikipedia/MySpace/Facebook that has sort of emerged in the last two years. And that did not exist. When we thought about routing, it was very rudimentary. It was, “How do I get your order between the various exchanges’ displayed liquidity markets?” Now it’s, “How do we keep that order between us,” and that conversation between us has expanded itself between agency brokers, principal brokers and anybody who operates a dark pool. So that social network is sort of a phenomenon I think in the last two years. I’m not going to give credit to NMS, but clearly, there’s some things that have happened over the last two years that, all of a sudden, people are knocking on each other’s doors saying, “We should talk.”

Mr. Domowitz: I agree with that. The interesting thing to me, though, is not the Facebook of Wall Street, although it’s not a bad analogy in some ways. It’s the fact that the economics got worked out in virtually zero time.

In other words … to the extent that I can say things date before NMS, certainly there was third-party distribution of algorithms, for example, which is at the core of a lot of these network interactions … or co-opetition among the sell side. That dates back several years. … So then the question was, well, how do you distribute it? And then distribution deals were made, right? There was a lot of — it was an important building block I think. …

Ms. Clary: If we go to a world where as a customer I would see any broker or any exchange as being the single point of access to some kind of routing technology that will go everywhere all the time, and in a way, give me access to a centralized market with a lot of little different corporate names on top of it, what will be the factor that will make the difference between all of those gateways to market liquidity?

Mr. Warren: I’ll take a stab at describing what I think the differentiating factors are going to be: What’s the level of liquidity? How quickly can you execute there? How stable is that portal? Because at the end of the day, people need to be filled with certainty, and that’s going to be the point of differentiation: Do you have liquidity, capacity and stability?

Mr. Misik: I think those are all very important, but quite honestly, I think we’re a long way away from that. I think that as a trader on the buy side, I have to have a certain set of tools. …

Believe me, in the last several years, having done a fair amount of research and having been exposed to every algorithm from every sell-side broker, and understanding every pool that they look into, nobody looks at everything. There’s — like saying the economics have been worked out to a certain point, Ian, but there’s a lot of people who don’t talk to each other and won’t talk to each other, because they can’t work out the economics, and so that goes to the confusion we spoke about earlier. …

That’s where it becomes incumbent on us to have that tool set that does evaluate exactly what Scot is saying: the speed; the access; knowing where the liquidity does lie, and the constituency even within liquidity … So we have to have great electronic tools at our fingertips with the ability to evaluate them pre- and post-trade to do an effective job.

Ms. Clary: Brian, on that topic, if we go back to the ECN war, when at one stage there was a dozen ECNs, and we saw two developments. Arca introduced routing, so that was to reduce the market fragmentation —

Mr. Hyndman: In all fairness, Bloomberg introduced it first, but that’s OK.

Ms. Clary: That’s not what Arca says.

Mr. Hyndman: I never worked for Bloomberg either.

Ms. Clary: Anyway, somebody introduced routing, and then we got into that price war where everybody was like, you know, it doesn’t matter if I have no liquidity whatsoever on my book, because I’ll find liquidity somewhere for you, and I’ll do it cheaper than anybody else. At the end of the day, though, we saw that the ECN that was really able to get the lion’s share of liquidity and retain it — meaning that it would not need to route — was Island. What do you think made the difference there?

Mr. Hyndman: Island clearly grew to about 10% of the market being just a true, true island. But I think … how they got to that next level was to really offer the routing functionality. At the beginning, it was a premium product, and probably by the time Island did it — with Instinet I think it was — it was a commodity product and ECNs were doing it at a loss just to get that flow on their book first before they routed it out. So … you can only be so successful without having the full suite of functionality. … They joined forces with Instinet, and that’s when they got up to that 20% or 25% market share. But Tal might know better than me on some of the specifics.

Mr. Cohen: Actually, I lived through it — unfortunately or fortunately — and actually Instinet was the largest ECN at the time of the acquisition. We were about 12%; they were about 11%. When we combined it, it looked like a 24% and it grew to about 28%.

But, once again, it isn’t one particular event that led to them capturing market share. There was decimalization. There was rebates. The concept of, “I have these trading models that would work if you provide me with a rebate.” And all of a sudden, they (the buy side) said, “Well, that makes sense. We’ll provide you with a rebate if you provide liquidity.” So there was decimalization. There was the rebate game. There was technology getting to the point where you could take 40 or 50 messages per trade, which was foreign to a lot of ECNs and ATSes (alternative trading systems) in the late ’90s, early 21st century, when a lot of these new liquidity providers — these 21st-century liquidity providers, such as hedge funds and high-frequency asset managers — were looking for the kind of stability and performance from a system that truly didn’t exist before that.

So, once again, there was a confluence of events that led to the rise of the ECN. And that market fragmentation, it’s actually funded these. I remember only 11 … and I think 10 out of the 11 actually ended up being bought or somewhat had a successful liquidity event/exit. Only one that I can think of actually, you know, never materialized. Everybody else either joined forces with somebody else, was bought, cashed out in some way. So it was actually a very interesting cycle.

Ms. Clary: So it seems that the winning proposition is to have — as Scot was saying — a significant amount of liquidity. You cannot be a successful market without any liquidity at all, and you need to be able to route to get the liquidity you don’t have.

Mr. Warren: Right. And I think Tim made an excellent point — that is a distant point in the future. But, Tim, would you ever have a single-threaded relationship?

Mr. Misik: No. Never.

Mr. Warren: You’re going to need multiple brokers or exchanges, because they can’t be entirely beholden to any one market center or any one broker.

Mr. Misik: And then there’s a number of reasons beyond just executing that makes a big difference.

Ms. Clary: Kyle?

Mr. Zasky: Just a point related to the ECN. Basically … EdgeTrade was one of the first companies to connect to Island, and that was before they reached that critical mass. Everyone agrees that … critical mass is going to help ensure your success. But, ultimately, all these organizations and parallels to the dark books today have to start from a zero point of liquidity. And the thing that Island did better than anyone, any of the other 10 or 11 players, is they were the fastest by far. I mean, we’d look at our DMA (direct market access) aggregator and we’d see a quote come in from Island first, and then several seconds later we’d see a couple of other ECNs follow, followed by the exchanges. So speed was one of the most important things. Then they put together a very unique pricing model, and that really helped them take off rather quickly. Maybe we can learn something in terms of, you know, what’s going to happen with this dark book fragmentation. Who’s going to survive and what will consolidate. What’s going to work and what not.

Ms. Clary: Ian?

Mr. Domowitz: I think your question about the point of differentiation — in other words, what will make those in the industry succeed and what may make them fail — is very important. It’s something that people around this table think about every day, but (is) all the more important in the context of the remarks made earlier about the brokers and the exchanges.

But in my opinion, liquidity in and of itself is not the answer. … Just to use some language that’s been used in the past few minutes, if it’s a critical mass of liquidity that’s important, by definition, that cannot be a differentiator because everybody must have a critical mass just to be in the game. Now it might take a little while for you to figure out that you don’t have one, but to be in the game, you must have a critical mass of liquidity.

So then the question is, is the differentiator having somehow more than that, the critical mass. But, again, by definition, it’s almost not an interesting question. So … then back to technology. Well, it’s one of these things where everybody’s got to have the technology on some level. The routing, all right, that’s been talked about in the last few minutes. Everyone now must do this, all right, by law or by necessity. … And so —

Mr. Hyndman: I’m sorry to interrupt. There is going to be a certain point of differentiation on the technology when it comes to speed and through-put and reliability and stability.

Mr. Domowitz: Money solves many problems, and technology is not created, typically, by the end users of the technology. In other words, we’re not — neither you nor I, Brian — are building the chips, right? We’re not building the grid processors.

Mr. Hyndman: But it’s tough to spend money on that technology to stay bleeding edge when you’re only capturing one (mil) on every trade.

Mr. Domowitz: Back to the critical-mass issue. In other words, what's the margin on what you absolutely have to meet? So, you know, I'm not really disagreeing.

Mr. Hyndman: OK.

Mr. Domowitz: There are nuances here. But what no one’s talked about is the service model. … (I)n my mind, the service model, broadly defined, will be the differentiator. I think these other things basically get leveled out … part of it by definition, part of it because there are things that are sort of out of margin that, in principle, you can spend your way out of. But the service model is not something you can just spend your way out of; that actually requires some thought … not just the purchase of the latest and greatest in terms of the technology. That is something that I believe the industry is now trying to figure out more than ever, and certainly since it’s been such a big part of the sell-side game, this is where it’s definitely relevant. …

Ms. Clary: That’s another very good point you are bringing up, Ian. Based on what you said, I think what made Island a success is that they clearly defined the type of clients they wanted to have, and they wanted to serve them better than anybody else. That raises a question: Regardless of the technology that allows us to be together all the time as a big happy family, is there not, by nature, a type of client that a type of firm or a type of exchange will serve better than anybody else? You cannot be everything to everybody.

Mr. Hyndman: I just somewhat disagree that Island succeeded. They weren’t the first to route. They weren’t the first to get the rebate. They had the best technology, and that’s what got them to 10% or 11% of the market share. No doubt about it. Kyle said it best: The technology is why people got connected to Island at the beginning. I am a big believer that that’s a big differentiator.

Ms. Clary: It is. But you also have to think that the reason Island was so good at developing that technology, is because they had realized that there was a relatively new segment of the marketplace where you had customers who were interested in technology, and it understood how they could leverage it.

Mr. Hyndman: Correct.

Ms. Clary: So Island was a specific answer to a specific type of client. Which makes me wonder: Can anybody be everything to anybody when it comes to best execution?

Mr. Warren: I think one of the things we have to ask ourselves is why was Island successful? They solved a problem. And how many of us in this room have ever been successful doing anything for a client that didn’t solve the problem? So to Ian’s point, yes, liquidity is a differentiator, because I’ve got to solve the problem for the client to aggregate that liquidity. So, which client segments you solve the problem for will speak to your future success.

Mr. Cohen: And, actually, the technology — back to Ian’s point — technology and service levels are not mutually exclusive. They’re very interrelated, and one thing that Island did very well is their decision on technology and their architecture allowed for a superior service model. It was really easy to maintain that code. It was really consistent. It didn’t pose a lot of problems in terms of maintenance. So when you think about technology, it’s not only who’s faster and who’s got more through-put, it’s, “Does this technology allow me to scale my service model?”

Ms. Clary: Right. And that was a little bit kind of new-frontier thinking … (of the people) at Island who maybe saw a new type of strategy and new type of constituents that were not widely recognized on the Street. What is interesting is that those clients brought the innovation that the institutional clients today benefit from with all of those sophisticated tools and algorithms. Scot?

Mr. Warren: I think it’s important that you keep pointing out the client segmentation. There was a disenfranchised segment that Island serviced, and they were vilified as SOES (small-order execution system) bandits, and … (Island) recognized that they could provide liquidity and solved that problem for them. So, again, can you be everything to everyone? I don’t know. Can you solve a lot of clients’ problems? Yeah. And that’s what you’ve got to do — continue to look to see which market segment you can solve the problem for.

Ms. Clary: So, Ian, we have actually touched on the question of closed pools and the best execution and the routing, but when, as a broker, you have to make the decision that, No. 1, you understand exactly who your clients are — what their needs are, what are the problems that you need to solve for them — then it comes to the decision of technology and financial decision (of) how many markets do I want to connect to, or does it make sense to connect to, in order to be able to solve the problems of my clients?

Mr. Domowitz: Well, our attitude is fairly simple: We aspire to them all. In other words, if you have a large client base, they obviously have a wide variety of both styles and desires. So being all things to all people in that particular sense, basically means the ability to connect rather widely, right? …

(N)ot just to market centers, not just to dark pools, not just to other alternative trading systems — whether they be called ECNs or not — but even to provide access to others’ algorithms. This is part of this social networking mentality, the co-opetition among the sell side, because the clients will tell you, “Well, we’d love to use your front-end trading system and we’re going to send you, you know, flow, but we need the ability to connect to, say, the following six algorithmic trading providers.” So you must make that available through either your order management or your execution management technology.

Ms. Clary: Ian, that’s really an interesting point that you are raising. Your clients today are fairly familiar with a number of different algorithmic solutions and they will tell you … “I like algorithm A, B, C, D, whatever, and please, if you want me to be your client, make sure you give me access to those market solutions.”

Mr. Domowitz: That is correct. The most sophisticated client level definitely demands precisely that.

Ms. Clary: When did that start? Did that exist three years ago? Two years ago?

Mr. Domowitz: It’s hard … to tack it down by the month, but I would say that this was sort of a growing issue starting at the beginning of 2006 … Algorithms were tested out. They were tried on for size by virtually every major buy-side shop in the United States. … (I)n this test period, were algorithms fulfilling their promise? Were they getting to their benchmarks? Were they actually acting as productivity tools the way they were advertised, and so on and so forth. All that needed to be assessed. As order flow itself — as opposed to just connectivity to an algo — became the order of the day, then the requests for that type of servicing certainly speeded up.

We purchased Macgregor (Group Inc.) in January of 2006. At that time, Macgregor was already distributing the algorithms of roughly 16 major market vendors. A total of almost 1,000 strategies, at least 200 on distinct strategies. … That was already in place through the order management system at that time. … What has kind of come on board and really followed that Macgregor build out was the demand that it be built into all these execution management systems, whether they were independents, like Portware, or provided by the sell side, such as our own Triton. So that has grown — I would say that growth is largely an issue.

Ms. Clary: Yes, Tim.

Mr. Misik: I’ve been a beta tester of program trading systems since the mid-’90s, and I think the time line for the sell side may be 2006. I agree, having been a consumer of a couple different sell-side execution systems, that … the independent providers, FlexTrade, Portware, you know, whoever they might be — obviously they’re agnostic to anybody’s algorithms. They really didn’t mind the co-opetition and the algo-into-EMS space really was forced upon the sell side within the past two years. I do agree with that. But it existed outside, in the EMSes, well before that.

Ms. Clary: You mean that this was forced on the sell side by the independent vendors?

Mr. Misik: By the buy side. By their clients. For us to consume an execution system, we have to be able to get to as many of those algorithms as we possible can. The ones, like you said, the ones that we want to. We want to be able to have access to X number of suites of algorithms from the various sell-side brokers.

Ms. Clary: The Street is a village where everybody gossips and talks about everybody all the time. Since everybody’s got an algorithm … is there a kind of natural selection, you know, where gentlemen go to a pub on Wall Street after dark and have a fun conversation about “this algo is incredible” —

Mr. Zasky: You’ve got to try to fish. … I really don’t intend this to be some sort of advertisement, but some people view algorithms as a utility that’s hard to tell the differences between their performance and what we should use in what circumstance. But there are different approaches that different companies have, even though there are a lot of providers of these types of algorithms, and I think over the next couple years — it’s starting to happen now — it’ll play out which algorithms are being embraced and which ones are not.

At EdgeTrade, one of our core competencies — and why Knight acquired us — is because of our algorithmic competency. And we’re already working on the third generation, and we’re trying to provide a value proposition to the buy side in terms of what these can do in terms of efficiency and anonymity, liquidity aggregation. Whatever the things that a good trader would have done historically on a single stock or portfolio of stocks, algorithms can be beneficial to them for a variety of things — current and future things that we can’t even contemplate. So there are going to be differences, and there are going to be systems and providers that will differentiate themselves, and all this competition is great.

Mr. Misik: To answer your question directly, as somebody who’s consumed an array of all of these algorithms for a number of years, yes, those conversations do happen. I would put a caveat on there, at the risk of making us buy-side traders who do talk about these things sound like nerds, there is not a lot of really unbiased statistics around algorithmic performance. It’s hard to compare somebody who trades and cares about VWAP (volume-weighted average price) vs. someone who cares about implementation shortfall vs. somebody who cares about trading into the close. You’re not probably getting an apples-for-apples comparison. But there’s definitely discussions of who provides better algorithms, and there is talk of some specific types of strategies and what algorithms do work. That definitely does happen.

Ms. Clary: Tal?

Mr. Cohen: I’m sure after a couple of drinks they all look the same to you. But there’s actually —

Mr. Misik: After no drinks they all look the same to me.

Mr. Cohen: There’s probably a few things I would think the buy side is looking at when considering vendors, in addition to who’s better and what allows me to do what I need to do every day.

One, the concept that broker neutrality is a payment mechanism. That often gets lost in this. In other words, I have to select an execution management system that will help me unbundle my trading, (and) therefore, act also as a payment mechanism. So I may actually take some of these algos, not necessarily because I love those algos but (because) it’s a way for me to pay that particular broker.

Second, if I’m on the buy side, I’m thinking about — when I select somebody — who’s got an open philosophy. It’s not what you have today, but, potentially, what you think you’re going to do over the next six to 12 months, as this continues to evolve. So you’re looking at your EMS or OMS, and it’s not an investment today: You’re thinking where will this product be in a year from now, and what is the philosophy of the firm, the vendor behind this particular product? Are they open? Are they committed to integrating different brokers, different strategies that I need, whether it’s just provincially in the U.S. or globally? So I think those would be two important things as you’re selecting a piece of software.

Mr. Misik: I would completely agree, because what is the difference between broker X’s VWAP algorithm and broker Y’s VWAP algorithm. On the margin you might be able to see something, it really doesn’t matter.

Ms. Clary: Scot. Tim touched on a very interesting point, which was the notion of having a client who was in the process of doing some transition management in the midst of the crisis. So, tell me you have the solution to those kinds of problems.

Mr. Warren: Well, I think, as Tim pointed out, one of his concerns is operational risk and impact on performance. That’s where some of the products that we offer provide a great solution … because it’s got the liquidity, the ability to move size so you’ll have minimal market (impact), but it opens up the ability to access multiple markets simultaneously, eliminate currency conversion issues, remove the operational risk and settlement, and transaction costs of being able to do one trade vs. a trade in six different markets simultaneously.

Ms. Clary: For the more traditional institutional client who does invest a lot in broad equity indexes, is there a real economic advantage in trying to increase his position, transition his position, by going through futures products?

Mr. Warren: There’s an advantage — it depends, obviously, on the trading strategy. If you’re trying to replicate a global equity portfolio, you can certainly do that with futures. You can do it with a total return swap. You can do it with some ETF products.

I think you’re going to find compelling cost advantages with the futures vs. many of those other products. You also have the ability of transparency of pricing. And more than anything, it’s liquidity in that product, in the ability to act quickly and use one trade rather than how many markets you need to trade.

The other thing you can do is, in volatile markets environments, take the beta component out and really deal with the stock-specific risk rather than market risk. Isolating your risk has benefits to the traders.

Ms. Clary: Do you think that the more traditional … institutional clients are realizing that in this kind of market condition, being able to take the beta component out is a real benefit?

Mr. Warren: Well, it’s back to the first question of what does best execution mean and what tools do you need. Part of it is judgment and flexibility of product type, because if you’re forced to go only to one market and one product, you really don’t have the latitude to exercise that judgment. So I think we’re seeing a lot more dialogue with the plan sponsors and their consultants in terms of what products do we have to arm the traders with to be able to carry out our clients’ objectives? And futures are certainly a valuable component in that tool kit.

Ms. Clary: We are getting close to the end of the session, and I would just like to ask all of you about this monumental proposal that Treasury Secretary (Henry) Paulson wants to push, where we would freely open the U.S. markets and every exchange around the world, or at least those with mutual recognition. … Without even asking whether it’s going to happen, is this really going to change the world? Ian?

Mr. Domowitz: Well, I think it already happened. Back to history. … Years ago, many years ago, long ago and not so far away in Chicago, the DTB (Deutsche Terminborse, the German futures exchange) put 26 terminals into Chicago for direct access into their futures trading facilities. This was provisionally approved by the CFTC. Whether or not it happened to be because of Europe or whether it was just market conditions, people at both the Chicago Board of Trade and the Mercantile Exchange at the time thought that maybe market share can suffer here. There was intense lobbying of the CFTC; the commission itself was split down the middle. It was a heck of a fight.

So we’re not looking at something completely new here.

Now is it going to be good for everyone? Well, generally speaking, I think the general tenor of the discussion around the table says that market access is a good thing, and that people will make intelligent choices based on the quality of the market, given the ability to access. So it’s hard to find something really wrong with this, unless one can actually track it back via the regulatory process to something that would actually hurt the retail investor, and I personally find that difficult to do.

Mr. Cohen: Not to disagree about this generally being a good thing, but before you can throw your support behind it, you need to know two things.

One is, who’s eligible? And it can’t go against the hallmarks of competition. In other words, if the exchange is only eligible for mutual recognition and the ATS is not, then that’s counter to much of the regulatory reforms we’ve seen over the last couple years. …

Secondly, you want to understand the rules of engagement and ensure that they don’t subtract costs from one area and add it to another area of a firm. So you look at it and say, “Well, it’s great. Now I don’t actually have to open up an affiliate. I don’t have to register. Time to market has come down. This is all really good news.” But then you read through the regulation and you find out, well, actually, what they’ve done is inserted a couple clauses in here that subject me to additional work that I actually didn’t consider before. So net-net, it has to be a win on the cost side, on the time to market side, and you have to ensure that while they go about this and make sure that it opens up the markets to the brokers, it doesn’t limit competition at the market level.

Ms. Clary: Kyle?

Mr. Zasky: Well, I mean, I don’t want to seem too philosophical, but if you think beyond today, tomorrow, a couple years, I think that anything that we can do to promote interconnectivity between countries and regions of the world … that’ll create a stable global community.

I mean, you build a financial infrastructure — a little wistful here — but I think it’s good for the world in general, beyond the financial arena, to have interconnectivity in terms of the financial markets.

Ms. Clary: Scot?

Mr. Warren: I agree with Kyle. And also, probably to echo Ian’s point, I think this is largely already taking place. Through brokers’ networks, market participants can access any of the foreign markets.

So the question becomes why, as an institutional customer or hedge fund, do I want to directly access the foreign markets and what’s the benefit of that, and what problems did I solve?

I think globally, you’ve got to welcome the opportunity to access other markets. Competition is good. You want to make sure that it takes place on a level regulatory playing field for all market participants, that everybody knows what the rules are, and that we have access to see what was done in those foreign markets. But, again, I think many of the benefits are already there because of electronic access to markets sponsored by front-end systems and brokers.

Ms. Clary: Tim?

Mr. Misik: I think technologically we’re really not that far away, to echo Scot’s points, but … you know, liquidity is paramount. … (A)re you going to have the liquidity in Europe at 3 in the afternoon? 3:30 in the afternoon in the U.S.?

You know, you have this cross-trading ability, is it really going to be an effective trading mechanism?

I’m all for sharing information, but it’s very difficult to think that that’s going to exist.

Ms. Clary: That’s an excellent point. It’s not because a market is open technically that something necessarily happens there.

Mr. Misik: Exactly.

Ms. Clary: Brian?

Mr. Hyndman: I don’t have anything to add.

Ms. Clary: Well, I’m certainly looking forward to hearing more about your connectivity projects.

Mr. Hyndman: And we will have more connectivity projects with our OMX acquisition. We will have connectivity to 65 exchanges worldwide.

Ms. Clary: 65?

Mr. Hyndman: Exchanges.

Mr. Misik: So we’re almost already there then, Brian.

Mr. Hyndman: We’re almost there, but it’s probably another five to 10 years.

Ms. Clary: Thank you all. You were great.