Regional stock exchanges are heading down a new path that could breathe much-needed life into their struggling business models. With the passage of Reg NMS by the Securities and Exchange Commission in April, the four regional exchanges - the Boston Stock Exchange, the Chicago Stock Exchange, the Philadelphia Stock Exchange and the National Stock Exchange - are being given an opportunity to become important destinations in the revamped national market system.
The regional exchanges have struggled for 30 years. Over the past five years, the whole regional system - which is based on regional specialist firms - has declined as decimal pricing led many specialists to consolidate their businesses with other firms or leave the exchanges. Further, regional exchanges have relied on payment for order flow practices as well as direct-brokerage programs whereby retail brokers send orders to certain floor brokers who will match the best price in return for compensation. However, this practice has declined as penny pricing has squeezed margins.
Additionally, the smaller regional exchanges - which are microcosms of the larger, primary markets - have had a hard time competing with the New York Stock Exchange (NYSE) and The Nasdaq Stock Market, especially in listed stocks, for which the Big Board has had the best price 95 percent of the time. Brokers and institutions tend to route their orders to the NYSE without taking into account the regional exchange prices because the NYSE has the deepest liquidity pool. Even when the regionals have a better price, the NYSE is able to ignore them because the current trade-through rule is not being enforced, says Benn Steil, Andre Meyer Fellow and director of the International Economics Program at the Council on Foreign Relations.
But, since Reg NMS mandates that all exchanges, brokers, institutions and ECNs route orders to the market displaying the best price, regional exchanges no longer will be overlooked. By requiring the NYSE to automate its quotations and route orders to any market that has the best price, Reg NMS potentially levels the playing field.
Now, the regional exchanges are positioning themselves to capitalize on the new competitive landscape. With the consolidation of the four largest players following the NYSE's merger with Archipelago and Nasdaq's deal with INET ECN, all four regional exchanges are competing to become the third player in the current duopoly.
To accomplish this, the regionals are forming strategic partnerships with broker-dealers and revamping their technology to become fast markets. And several are demutualizing their nonprofit ownership structures by converting into for-profit commercial enterprises, with the potential for going public in the future. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio