Do We Need Another ECN?

by Ivy Schmerken

Women used to say you can never be too rich or too thin. Well, that has been somewhat discredited. But in Wall Street these days, the belief is that you can never have too many ECNs. With new stock trading rules-Regulation National Market Structure (NMS)-officially kicking in by the end of June, broker dealers are hedging their bets to position themselves for a post-Reg NMS world.

Last Wednesday, the Wall Street Journal reported (subscription required) that Citigroup plans to launch its own electronic trading network this spring. This move follows Citicorp's acquisition of OnTrade, a wholly owned subsidiary NexTrade Holdings in Clearwater, Florida, and the hiring of Steve Randich, former CIO of Nadaq, notes David Easthope, analyst with Boston-based Celent.

NexTrade operates its ECN - Electronic Communications Network - through OnTrade, its wholly owned subsidiary. One source tells me that Citi is buying OnTrade for its ECN license and then plans to rebuild the technology.

The paper says that Citigroup will operate the new electronic trading network separately from its business of executing trades for clients. And Citi's ECN will be accessible to other Wall Street firms trading stocks, according to the article. Of course that opens a whole Pandora's Box of whether firms will feel comfortable using a competitor's ECN - an issue that Citi has already had to face with its acquisition of Lava Trading, a leading technology provider that operates a smart-order routing service bureau used by other sell-side firms and their buy-side clients.

Sources interpret Citigroup's move to offer a new ECN is a defensive move against the duopoly - the New York Stock Exchange and Nasdaq - raising prices charged to brokers. If you're a brokerage house in the stock trading business, you might want to go out and buy your own ECN rather than pay higher transaction fees to the NYSE and Nasdaq.
But isn't this overkill? Citigroup has already invested in the Philadelphia Stock Exchange last June and in the Boston Stock Exchanges' electronic trading ventures in August. Those investments, made in conjunction with other Wall Street heavy hitters, are meant to give the industry another alternative to the duopoly.

Because of all the uncertainty surrounding Reg NMS and how it's going to play out, brokers are investing in ventures that can help them generate market data revenues and avoid paying fees to other venues. But does the industry really need another ECN? As everyone knows, there were as many as dozen ECNs created during the late 1990s as Wall Street firms placed bets on electronic trading. Remember Strike, REDIBook, BRUT, GlobeTrade, Island, Attain and MarketXT? All of these ECNs have either merged with other ECNs or pulled the plug.

After a wave of consolidation and mergers, now there are only a few independent ECNs left as many have been acquired or simply gone out of business for lack of liquidity. Why let history repeat itself?

Standalone ECNs may not be viable judging from the fact that the two leading ECNS - Archipelago and INET -- are merging with the stock largest exchanges. The remaining independents are Track Data, Bloomberg Tradebook and a new start-up, BATS Trading. (Attain was acquired by Knight Trading). What's more, stock trading may not be enough. Bloomberg Tradebook ECN recently received SEC permission to offer options trading. On the other hand, this does not preclude Citi from expanding into other asset classes down the road.

One analyst thinks the Citigroup ECN is a smart move. “It makes sense for Citigroup to attempt to capture more of this trading and to provide an alternative venue to the existing ECNs, which are becoming indistinguishable from the exchanges due to mergers,” comments David Easthope, an analyst with Boston-based research and consulting firm, Celent, in an email last week.

In theory, ECNs should benefit from the new regs which require trading centers to route orders to the destination displaying the best price. If ECNs have the best price, other trading centers are obligated to hit them first. Then, ECNs could improve their internal match rates without having to route out and pay fees for taking another venue's bids and offers.

If that's the case, then other banks could form ECNs too, that is, if they want to undertake the technology risk. So when the question arises, do we really need another ECN?, a seasoned source replies, “You can never have enough.”

Posted by Ivy Schmerken at 10:02 AM

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