The corner of Wall and Broad Streets in lower Manhattan has long been dominated by the imposing Corinthian columns of the New York Stock Exchange. But in an anonymous building a few doors away, a revolution in share trading is gaining momentum.
These are the makeshift offices of Island, one of the largest and most aggressive of a new breed of electronic trading networks. These electronic communication networks or ECNs are increasingly competing with established exchanges for share trading business. In three years, Island has grabbed a significant share of trading in shares listed on Nasdaq, one of the two main US exchanges.
US financial markets are on the brink of far-reaching structural change. The barriers that have kept most US share trading with NYSE and Nasdaq are breaking down. The old order has been undermined by deregulation and changing technology.
The new networks are electronic marketplaces in which orders placed by buyers and sellers of shares are matched automatically. Rather than acting as dealers - making money on the difference between buying and selling prices - they charge a fee on each trade. They have flourished because of their speed and the low cost of transactions, and today handle some 30 per cent of trading in Nasdaq shares.
Now the established exchanges are being forced to change strategies. Last week, Mr Richard Grasso, the NYSE chairman, confirmed a plan to implement changes to trading on the exchange by using ECN technology and extending trading hours.
The exchange hopes to co-opt the newcomers' technology to provide a new channel of access to stocks on Nasdaq, its rival stock exchange. Nasdaq is also negotiating with the networks and is considering extending its trading day.
Most analysts expect the current upheaval to lead eventually to a more transparent, low-cost and efficient marketplace. But the rivalry between networks and exchanges has fostered confusion and fragmentation in the short term. The transition to a more fluid electronic marketplace will not be smooth.
The growth of electronic networks has been stimulated by several factors. First was a 1997 ruling by the Securities and Exchange Commission, the chief US stock market regulator. The changes followed charges of collusion among Nasdaq dealers and an antitrust inquiry by the US Department of Justice. The 1997 rules allowed networks more access to Nasdaq.
Second has been Internet-based trading in shares by retail investors. This has spurred growth because online brokers tend to channel orders through networks rather than exchanges.
Third has been the advantage networks offer to large funds. In Europe, institutional investors have used brokerages such as Instinet, owned by Reuters, the financial data group, to keep large trades secret.
So far, the London Stock Exchange and its continental European counterparts have been able to shrug off the challenge from upstarts. They have also fought back to protect their patch, as the bourses did earlier this decade when they saw volume draining to Seaq International in its heyday.
But if electronic networks have provided more choice for investors, they have also multiplied the complications. There are already nine networks competing for trading business in the US market, and more are likely to follow. Since the many ECNs operate on separate networks, each compiles its own separate universe of buy-and-sell orders. These are compiled into a trading system that Nasdaq traders can access. But outsiders, especially individual investors, have no guarantee they will get the best price available, since it may occur on a different system than they can access at a given time. And the more that trading is channelled through different networks, the harder it may become for regulators to do their job. Greater exposure to ECN technology could expose trading to glitches if not handled carefully.
The networks are already responding to this by forming alliances and discussing mergers. They suffer directly from fragmentation because this makes it harder for any single network to gain enough business to make profits. This is even more pressing for networks than exchanges, because exchanges are traditionally mutually owned and run.
Exchanges are also working feverishly behind the scenes to incorporate the latest technology, rather than see their flow of orders diminish. They are trying to form alliances with groups of networks to capture the order flow that is now eluding them. If the exchanges can bring off such alliances, it could give them benefits hard to imagine a few years ago. Mr Grasso of the NYSE has long sought access to Nasdaq shares. Nasdaq constituents include heavily traded stocks, such as Microsoft, Dell Computer and Intel.
Even if Mr Grasso succeeds, he may not be able to forestall the growth of other networks. As he announced his plans for longer opening hours, he said he could not yet see demand for such trading. But these days, no exchange can take the risk of being outflanked.
