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As part of the extreme makeover of the National Market System, the SEC's Reg NMS proposes that market centers route orders to the venue that offers the best price.

The Issue Defined: As part of the extreme makeover of the National Market System, the SEC's Reg NMS proposes that market centers route orders to the venue that offers the best price. This fundamental shift in the way equities are traded would require significant systems changes and technology investments.

Why It's Important: To ensure that investors get the best deal when trading stocks, the SEC's Reg NMS would require market centers to route an order to the market that shows the best price. The rule currently is known as the Trade-Through Rule but has been coined the Order Protection Rule in the reproposed Reg NMS. Markets will need to provide automated quotes to ensure that other venues do not ignore their prices. Currently, markets publish their best bids and offers, known as top-of-book. But, because it is difficult for institutions to execute large orders at a single price point since liquidity is often dispersed away from the best price, the SEC also is proposing that market centers voluntarily publish all the bids and offers on their order books, known as depth-of-book (DOB). Institutions could then capture liquidity at multiple price points. If brokers and buy-side firms are required to trade across market centers, links will need to be established among all the markets. (Nasdaq and the ECNs currently are connected via private linkages; the NYSE, Amex and the regionals rely on the Intermarket Trading System [ITS] and would have to establish connectivity.)

Where the Industry Is Now: The SEC published the reproposed Reg NMS Dec. 15. The 30-day public comment period ended Jan. 26. The SEC will review comment letters and vote on a final rule early this year.

Focus in 2005: Market centers, broker-dealers and institutions will focus on the technology requirements and costs of complying with Reg NMS. If the Voluntary Depth Alternative is approved, Securities Information Processors (SIAC and Nasdaq) may need to aggregate all of this information. Huge increases in bandwidth could be required for firms that take in direct exchange feeds and the market-data aggregators that disseminate these feeds. Market centers will also need to determine how they will be linked to each other.

Who's Leading the Charge: ECNs and Nasdaq already have smart-order-routing technology, but the NYSE does not. Alternative trading systems (ATSs), such as POSIT, Liquidnet, Harborside+ and Pipeline, may have an edge, since firms can use these systems to protect their anonymity. However, under Reg NMS, ATSs may be forced to disclose their quotes if trading volume surpasses a predetermined level.

Some Vendors in the Space: Financial extranets include Radianz, Savvis, TNS and Thomson AutEx, and other order-routing networks such as NYFIX. Sell-side OMSs will capitalize by helping brokers execute against displayed orders and move down the book.

Associated Costs: The SEC estimates total industrywide start-up costs at $143.8 million and annual costs at $21.9 million to set up procedures, policies and market-monitoring systems and modify order-routing systems to comply with Reg NMS. Modification of order-routing and execution systems could impact approximately 600 broker-dealers, including ATSs. Twenty trading centers that currently rely on their own internal order-routing and execution-management systems could spend about $3 million each to adjust these systems, while the vast majority of firms that rely on vendors would pay around $50,000 each.

Industry Perspective: "The virtual CLOB [centralized limit order book] presents a recipe for bad execution that would drive institutional price discovery [upstairs] to trading desks and out of the marketplace, generally because institutions will not disclose all of their interest all of the time," says Bob McSweeney, SVP for competitive position at the NYSE.

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

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