Majestic Research

Finanical Times

Taking the Floor: How a Screen Role Will Challenge New York's Market Debutant

By Jennifer Hughes and John Authers in New York
Published: March 07, 2006

When Kevin Feeley takes up his position on the floor of the New York Stock Exchange tomorrow, he can expect to be the centre of attention. He will be making a market in NYX, the stock of the NYSE Group itself.

The world’s largest stock exchange completes its merger with the Archipelago electronic trading network today and dealings in the stock will bring an end to more than two centuries as a mutually held club. But that is almost the least of the changes at the so-called Big Board.

Until now, trading has been exclusively in the hands of “specialists” like Mr Feeley, of Bear Wagner, and brokers who make their deals pacing the floor of the exchange. With the acquisition of Archipelago, the NYSE is ready for a “hybrid trading” model that combines an electronic trading platform - conducted by computers without human interaction - with its famous floor. It is a fundamental shift.

The NYSE is not alone. Its near neighbour, the New York Mercantile Exchange (Nymex), which dominates global oil markets, will next month begin its own revolution by offering electronic trading of its crude oil contracts side-by-side with the heaving mass of humanity in its trading pits. Jim Newsome, Nymex’s president, says he expects “the floor will remain an active part” and notes that it was floor traders themselves who pushed for more electronic trading. And members of the Chicago Board of Trade (CBOT) will tomorrow vote on whether to give the exchange’s board the authority to look into a “side-by-side” model for its key agricultural contracts.

In Europe, electronic trading is the norm and open-outcry floors are viewed as an anachronism. At the London Stock Exchange, screen-based trading was introduced alongside open outcry as part of the “Big Bang” operational overhaul of 1986. It rapidly triumphed and the floor was closed within weeks.

“America is lagging behind. Electronic trading is inevitable - it truly is,” says Tony LaPorta, a former pit trader on the London International Financial Futures and Options Exchange (Liffe), which switched rapidly to electronic trading in 1998 after Eurex, its all-electronic rival, stole its benchmark Bund contract.

But the NYSE is in a different league. As John Thain, its chief executive, points out, the market value of companies traded on New York’s floor is $21,000bn - more than the Tokyo, London, Nasdaq, Euronext and Deutsche Börse exchanges combined. If the NYSE goes fully electronic, it would truly be the death of floor trading. Will that happen?

“People have talked about this ‘death’ for the last 15 years and no one has yet been right,” says John Lothian, head of electronic trading at Price Futures Group, a Chicago brokerage. “But the confluence of the changes at these three could well make this point - in hindsight - one of significance.”

Doug Atkin, a former Instinet chief executive who now heads Majestic Research, suggests the future of the floor hinges on the NYSE’s battle for market share with its (fully electronic) rival Nasdaq. “If Nasdaq makes even moderate progress, then Thain has got to go electronic,” he says. “I think hybrid trading will last a year but I don’t think it will last much longer.”

Mr Thain says the model could last longer and the main reason for offering electronic trading is to increase volume - the key to profitability for all exchanges, which make their money on the commissions charged on each trade. “We traded more than 3bn shares on two occasions [last year],” says Mr Thain. “So far this year we’ve been trading 1.7bn shares a day. If we want to trade 6bn or 7bn shares a day, we have to automate more of what’s going on on the floor, so they [the traders] don’t have to deal with orders that the computers can simply match. Whenever there are imbalances, you will be using the floor.”

He suggests that only about 200 of the 2,780 NYSE-listed stocks are liquid enough to trade electronically most of the time and that the “vast majority” would not trade very well on screen.

Experience on the Chicago Mercantile Exchange is also instructive. In 2000, daily volume on its Globex platform averaged 137,000 contracts a day. So far this year, it has averaged 3.3m contracts a day. “We can only go by what our customers are asking for and, right now, that’s more and more electronic access,” says Terry Duffy, chairman of the CME and a former independent floor trader.

The CME has invested more than $1bn over the last seven years in its technology. However, Mr Thain and others who believe in a hybrid model note that the CME’s floor trading volumes are also greater than they were in 2000.

Another factor pushing the NYSE is regulation. The Securities and Exchange Commission last year announced a new Regulation NMS ("National Market System"), designed to bring some common rules to the various electronic communication networks and alternative trading systems that are competing to provide a venue for stock trading. The rules will split US stock exchanges into “slow” and “fast” markets based on their ability to offer automatic and immediate execution of trades.

“Fast” markets will have to link with each other and match each other’s best prices in order to execute trades. For the NYSE, this opened the risk that “fast” markets would be allowed to ignore better prices on offer at “slow” floor-based exchanges.

Harrell Smith, head of securities and investments at Celent, a Boston-based consultancy, says: “Without Reg NMS, the NYSE would not have been forced to merge with Archipelago or go to the hybrid model. It did that in response to the writing on the wall from Reg NMS.” He predicts the NYSE will close its trading floor within two years.

To those who witnessed the changes in Europe, electronic trading appears inevitable. It is faster and opens up trading to new participants, expanding liquidity and reducing the clubbiness that still characterises many US exchanges.

“Before, if I were going to trade eurodollars on the [Chicago] Merc, I’d call my broker, he’d call the floor, the floor broker would hand-signal the clerk, who’d tell the pit broker,” says Mr LaPorta, who now runs the Power Points trading consultancy in Chicago. “He’d fill my order, tell the clerk, who’d signal the desk, who’d call my broker, who’d call me. You’ve now eliminated all that and given the outside man a chance - electronic trading levels the playing field.”

But some products have proved more adaptable to the screen than others. The CME and the CBOT, its cross-town rival, have successfully transferred their financial flagship products - eurodollars and Treasury futures respectively. Agricultural futures, which have an uneven seasonal calendar and are less liquid, have proved stickier.

“I don’t have a crystal ball but I think floors will be around for longer than people think,” says Charles Carey, chairman of the CBOT. “With the more complex trades and products, there is still value to having somebody there.”

Mr Thain adds: “Unless a company is very liquid, if you want to put an order in for 10,000 shares and there doesn’t happen to be 10,000 shares to sell at that price at that moment, you drive the price up . . . But a market-maker will fill in the extra. They can say: ‘There’s 8,000 for sale and I will fill in the extra 2,000.’ That’s what specialists do. They make the stocks trade in a less volatile way.” When companies move from the Nasdaq to the NYSE, he says, their volatility during each day drops by 40 to 50 per cent.

The biggest factor screaming “inevitable”, perhaps, is that electronic trading, without the necessity of a physical location, has levelled the playing field for an exchange’s rivals and made it easier to steal products - which drives the loser to follow suit (a process that Regulation NMS will accelerate).

Just ask Nymex. Last month its rival, the InterContinental Exchange (ICE), launched an electronic version of Nymex’s flagship West Texas Intermediate crude contract. ICE already accounts for 10 per cent of total WTI trading. It was shortly after that launch that Nymex announced its own side-by-side electronic and floor trading, due next month.

It does not work in the other direction. When ICE last year closed the London floor operated by its UK arm, formerly the International Petroleum Exchange, Nymex opened a rival London floor to entice ICE e-trading malcontents. But while ICE’s electronic trading volumes have soared, Nymex yesterday said it would close its six-month-old venture.

The final word on the future of Mr Feeley and his friends, fittingly, will be from the market. As Mr Thain himself admits: “We will give our customers choices and the market will evolve as it will evolve. And we will let it evolve.”