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Chermaine Lee, analyst, securities and investments group, Celent
Chermaine Lee, analyst, securities and investments group, Celent
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NYSE Specialists Rarely Improve Price Quality

While NYSE specialists have picked up their execution speeds, they rarely provide price improvement. The bigger story, however, may be their declining share of executions in NYSE-listed issues.

Chermaine Lee is a New York-based analyst in Celent's securities and investments group. Her current research covers direct market access and electronic bond trading in the United States. Lee has a B.S. in economics from the London School of Economics, where she specialized in international economics and finance.

Celent's latest report in a series of studies analyzing market centers' execution quality covers execution quality in the NYSE Market. The data used in this study draws from the monthly Rule 605 reports mandated by the Securities and Exchange Commission (SEC). Voluminous amounts of data were collected from December 2007 through February 2008, representing more than 15.9 billion orders and 176 market participants. Within Celent's methodology, two basic factors are considered: the speed of execution and the prices achieved. To determine price performance, the effective-over-quoted spread was determined for a variety of different order types, sizes and liquidity tranches.

ArcaEx, UBS Securities, Direct Edge (EDGX) and Automated Trading Desk (ATD) provided trade execution for the largest number of issues, with each of these venues providing executions for more than 8,000 issues from December 2007 through February 2008.

Exchange specialists are the main players in NYSE-listed issues execution, with a combined market share of 66 percent. But the more riveting story is their declining stake, with top specialist La Branche falling to 17 percent from 22 percent in the September-to-November 2006 period. With Susquehanna terminating its services and Van der Moolen assets being purchased by Lehman Brothers, there has been a shake-up among the NYSE specialists. Lehman Brothers brought over Van der Moolen's specialist services and has an 8 percent market share, while PSG has expanded its share from 1.8 percent to 3 percent. Talk about eliminating NYSE specialists altogether may be premature, but their declining share versus Nasdaq's growing market share (9 percent) in this period is something to watch out for.

One of Celent's main findings was the evolution of market centers' execution speeds in least-active issues from 2006 to 2008. In 100-499 shares, the average execution times have fallen by 93 percent from 7.99 seconds to 0.62 seconds in this study. In particular, specialists notorious for their slow execution speeds have improved their times by 99.8 percent within the past two years. Clearly, the increasing electronification of markets, due to regulatory demands such as Reg NMS and greater pressures for lower latency, has substantially reduced times across the various venues.

Moreover, execution venues' average speed quality seems to be converging: The standard deviation in this period for the 100 most active small market orders was 0.14 seconds, versus 0.85 in the previous report. On the contrary, price quality among the largest market centers may be diverging in the category of the 100 most active large marketable orders: The standard deviation increased by 178 percent.

Reduction in Price Improvement

With regard to the evolution of price quality, an apparent trade-off of the NYSE Hybrid Market developments has been the reduction of price improvement by specialists in the 100 most active NYSE stocks. From a healthy 24 percent price improvement of incoming orders in 2006, specialists' frequency of price improvement has fallen to 4 percent. But this was up from a dire 2 percent in our last study. Compared to market makers that improved prices on 57 percent of their orders and electronic order books that improved prices on 21 percent of orders in this report, specialists' price quality is lagging behind the other market centers.

Orders were categorized into a number of different segments using a variety of criteria, including order type (market or marketable limit) and size (small or large), as well as the liquidity segment (15 most active, 100 most active, mid-active and least active).

Direct comparisons between very different market models is sometimes fraught with difficulty, hence the rankings should be viewed as a guide, not as a substitute for common sense.

Among the major electronic order books, Nasdaq MC topped both the speed and price tables, overtaking ArcaEx, which was the fastest for incoming orders in the last execution quality report. From last place in terms of overall speed, BATS Trading has improved its position by two places and now stands at mid-table.

ATD achieved the best prices for client orders, while Knight executed incoming orders at the fastest rate for the major market maker category. In this category, we included market makers that provided executions in at least 2,000 issues and that accounted for at least 1 percent of the order volume. Market makers that fit this profile are (in alphabetical order): ATD, Citadel Derivatives, E*Trade, Knight and UBS Securities.

This time around, Wagner Stott Bear had the best prices among the exchange specialists, while La Branche's data revealed it to be the quickest in executing incoming orders.

Lehman Brothers' platform (LATS) reprised its position as the quickest market center in the whole study, executing the 100 most active small marketable orders at 10 microseconds -- beating its previous record of 55 microseconds. While Celent has confirmed Lehman Brothers' numbers in the firm's Rule 605 filings, it is difficult not to treat this figure with suspicion. At these kinds of speeds, Lehman Brothers seems to be getting close to bending the laws of physics. After all, at the speed of light, in 10 microseconds you would only get to Greenwich Village from the NYSE.

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