March 14, 2008

While NYSE Euronext has some very high-profile assets -- namely the NYSE, Archipelago and Euronext -- one of its less-high-profile assets may be one of its most important: NYSE TransactTools. For those who don't know, TransactTools was a developer of FIX-enabled connectivity platforms and management tools that NYSE Euronext acquired in 2007. Soon after the deal closed, TransactTools was given charge of the NYSE's network (SFTI -- pronounced "safety"). Earlier this year, NYSE TransactTools acquired Wombat, one of the leaders in high-speed/low-latency market data distribution platforms.

So why should we care about an exchange-based, FIX-engine provider tied to a network and a market data distributor? The answer is, TransactTools could be the ticket to the NYSE's survival.

To say the business of matching equity orders is competitive is an understatement. Exchanges and ECNs, such as Nasdaq and BATS, are forcing net trading fees down to one or two cents per hundred shares, and in some cases, ECNs such as DirectEdge are giving the service away. In addition, brokers are developing dark pools and crossing engines that attempt to match buyers and sellers even before the transactions hit the exchanges.

Volume is key to dark pools' success. The more volume, the greater the chance orders will match and never make it to market. This would be fine for the exchanges if order flow was evenly disbursed among brokers.

According to SIFMA, however, the revenue concentration among the top 10 brokers -- the very firms looking to match trades before they reach the exchanges -- is at an all-time high. Between 1980 and 2000, the top 10 revenue concentration fluctuated between 48.3 percent (1998) and 58.8 percent (1984). Since 2000, though, the revenue concentration of the top 10 firms jumped from 50.8 percent to 72.5 percent in 2006 (the last year they had statistics). This means the other 5,000 or so brokers shared just 27.5 percent of industry revenues.

So where does NYSE TransactTools fit into the equations? One of the critical factors driving flow to the largest brokers is IT. As electronic trading, algorithms, latency, speed and liquidity pool connectivity become more critical, the amount of technology needed to trade becomes more significant. The more expensive it is to acquire this technology, the more difficult it is for the small and midtier players to compete with the top brokers. TransactTools is one of the only firms that can change this equation.

Since everyone trading at the NYSE needs to be connected to SFTI (the only way to get to NYSE) and NYSE is connected to all other markets (a Reg NMS requirement), that means SFTI is the only network that literally connects all U.S. brokers, exchanges and ECNs. If TransactTools, via Wombat, can develop an effective, cost-sensitive hosting solution in the SFTI network, NYSE TransactTools can begin to bring down the cost of high-speed/low-latency market data needed to trade. And if NYSE TransactTools can embed low-latency transport, a set of flexible algorithms, a DMA/EMS platform, CEP and a time-series database into SFTI, NYSE TransactTools can begin to empower the midtier and smaller brokers that are quickly being shut out of the market.

Now there are a lot of "ifs" here. But if NYSE can't tackle this, what stops the larger brokers, dark pools and ECNs from getting even larger and eventually toppling the exchanges? So while nothing is certain, at least NYSE seems to see that its future is directly aligned with the plight of the small and midtier brokers. And while no one at NYSE Euronext is saying this, it looks like the exchange is positioning itself to help. <<<

Larry Tabb is the founder and CEO of TABB Group, the financial markets' research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on the interview-based ...