The top players in Nasdaq stocks, Instinet and SuperMontage, will continue to battle for liquidity in 2003.
Now that the lines have been clearly drawn in the battle for transaction supremacy in the Nasdaq Stock Market, the events of the next year may well determine the ultimate winners and losers.
The Instinet/Island electronic-communications-network (ECN) tandem still must complete the integration of its matching engines, and subsequently figure out where it's going to post its combined over-the-counter stock quotes. Meanwhile, Nasdaq, in an effort to keep pace with Instinet/Island, may have to consider opening up its SuperMontage network to competitor exchanges.
SuperMontage, the advanced order-display and execution network launched on Oct. 14, 2002, was designed, in part, to help Nasdaq recapture order flow it had lost to ECNs - particularly to Instinet and Island - over the last five years.
Nasdaq wanted to fight back against ECNs by building a centralized, transparent liquidity pool, through which market makers and broker/dealers could get immediate access to the five best bids and offers for any given stock. Such a system, Nasdaq reasoned, could revitalize its order routing and execution business while eating into the market share of Instinet and Island.
But in the first month of trading on SuperMontage, Nasdaq's strategy has proven flawed. Instinet/Island has maintained its status as Nasdaq's liquidity kingpin.
In a three-week period from Oct. 21 through Nov. 8, Instinet/Island recorded market share between 29 and 32 percent in Nasdaq stocks. SuperMontage, in comparison, has hovered between 20 and 30 percent market share since its launch, says Nasdaq Executive Vice President of Transaction Services Dean Furbush.
To be fair, as of Nov. 8, Nasdaq had rolled out only 385 of the roughly 3,950 stocks it planned to list on SuperMontage - with the full rollout scheduled to be completed by Dec. 2. It is also true, however, that Instinet/Island have managed to retain their transaction supremacy, despite the fact that the former archrivals did not complete their merger until Sept. 20, 2002. What's more, they have only just begun to work on an integration project that will ultimately unite their matching engines.
Ed Nicoll, the former Island chairman who now serves as chief executive officer of Instinet, says that the matching-engine integration should be finished in "six to 12 months."
After the matching engines are melded, Instinet will have to address another key question: Where should it post its collective Nasdaq quotes? Currently, Island displays its Nasdaq quotes on the Cincinnati Stock Exchange, an all-electronic regional stock market. Instinet, on the other hand, displays its Nasdaq prices on the National Association of Securities Dealers' Alternative Display Facility - a quote display and trade-printing system created via a Securities and Exchange Commission mandate.
Instinet has not totally ruled out listing its combined OTC quotes on SuperMontage at some point in the future, but - since Instinet still believes that Nasdaq's network favors market makers over ECNs - that scenario seems highly unlikely to unfold.
Nasdaq, for its part, remains frustrated and puzzled by Instinet/Island's decisions to post their quotes outside of SuperMontage.
"SuperMontage is performing exactly as we expected. It's designed to have zero locked and crossed markets within the system. It's designed to be fast, and allow access across all investors, in whatever way that they choose to be accessed," says Nasdaq's Furbush. "(So) I've really been sort of confused, in terms of (Instinet/Island's) efforts to serve their customers the best they can. What it is they are telling their customers, as to why they think it's better to be away (from SuperMontage), is a mystery to me."
But Nicoll does not buy Nasdaq's "confusion" assertion. "I think that's a disingenuous remark. They know exactly why we haven't posted. There are many ways that the system is designed to prefer the dealer quote over a non-dealer quote," he says.
SuperMontage: Reaching Out to Competitor Exchanges?
In addition to not offering access to the quotes of Instinet and Island, SuperMontage will soon be cut off from the liquidity of Archipelago - the third largest ECN.
SuperMontage currently displays prices from four ECNs: Archipelago, Brut, Bloomberg Tradebook and Track. Out of that group, Archipelago is the largest liquidity provider. In fact, during the week of Nov. 4, 2002, Archipelago accounted for 9 percent of SuperMontage's total volume, trailing only market maker Knight Securities (9.6 percent).
However, early in 2003, Archipelago plans to list all of the Nasdaq stocks it trades on its all-electronic stock market, the Archipelago Exchange.
After that migration takes place, SuperMontage - which does not route orders to execution destinations outside of its network - will be unable to offer access to liquidity providers that account for nearly two-fifths of the total market share in Nasdaq stocks.
"SuperMontage is a very good system from a technology perspective ... but it does have its limitations," says Matt Andresen, the former Island chief executive officer who recently accepted a position as head of global trading at the securities firm Sanford C. Bernstein.
"To the extent that (Nasdaq is) a smart order router, (it is) only able to go to people that are SuperMontage participants. That means, right now, that they can't send orders to Instinet or Island, and very soon won't be able to send to Archipelago ... . That's roughly 40 percent of Nasdaq volume that will not be accessible via SuperMontage," says Andresen.
In an effort to shore up this deficiency, Andresen predicts, Nasdaq will likely try to expand SuperMontage's reach by forging relationships with regional equity markets - such as the American Stock Exchange - that currently trade Nasdaq stocks under the Unlisted Trading Privileges (UTP) Act. "I think that will be a change that you will see (next) year," he says.
Furbush says that Nasdaq has, in fact, already built a SuperMontage link to the Chicago Stock Exchange. "We encourage linkage to any entity that wants to link in, including an exchange that is competing with us ... . (Chicago) is a competitor exchange, with whom we have worked out a relationship that has them smack dab in the middle of SuperMontage, executing orders, with no locked and crossed markets," he says.
Furbush also says that Nasdaq would welcome "similar linkages" with other UTP exchanges that trade Nasdaq stocks, but only if such an interface would not "degrade" SuperMontage's business model.
With so much change on the agenda next year, it is difficult to predict, with any certainty, which Nasdaq liquidity provider will emerge victorious. But Sang Lee, an analyst covering e-trading at the research and consulting firm Celent Communications, is a big proponent of SuperMontage.
In fact, by the end of 2003, he projects that SuperMontage will account for nearly 50 percent of the total volume in Nasdaq stocks, while Instinet/Island will have a market share of between "15 and 20 percent."