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Making Markets Move

The race to become a fast market may lead exchanges to join forces with ECNs.

So, What Are INET'S Options?

Prior to Nasdaq's acquisition of BRUT, INET had agreed to participate in SuperMontage, meaning it would give SuperMontage's participants access to INET's book of liquidity. It had also agreed to license its smart-order router to Nasdaq. In its March quarterly 10-K filing, however, Instinet Group indicated the deal was on hold. "We had a lot of technical priorities that were associated with merging [the Island and Instinet] books. Then, in the midst of that, Reg NMS came out," Goor says. "Reg NMS really does, through several of its proposals, cause us to question what the best course is, so we're on hold right now," adds Goor, who admits that Nasdaq's acquisition of direct competitor BRUT also gave INET "pause."

In considering the best course, INET has several options: INET could file for exchange status with the SEC, or it could partner with an exchange. If INET were to file for exchange status, however, it would need to file a formal application with the SEC - which can take years to be approved - and, ultimately, it would need to set up a whole regulatory infrastructure. "As an exchange, you need to create all of that - and it's not that cheap," Financial Insights' Kovelsky says.

Since there is evidence that filing a formal application for exchange status with the SEC can take too long - Nasdaq filed for an exchange license with the SEC more than three years ago and is still waiting for approval - acquiring or partnering with an exchange would likely be a quicker strategy for INET to pursue. This move would follow the route that Archipelago took in acquiring the equity business from the Pacific Stock Exchange (PCX) in 2000. INET would still need to file documents with the SEC, but the process is shorter - in Archipelago's case, it took about a year and a half. INET could potentially operate as a trading facility of the exchange and reap the benefits of having an exchange license.

"Certainly, partnering with or purchasing a regional exchange might be an attractive option for them," says Jeff Brown, director, product development at UNX, an institutional brokerage firm in Burbank, Calif., of INET, noting that the move would mimic the route taken by Archipelago.

A senior executive at an INET competitor who requested anonymity says there is talk that INET is trying to follow the Archipelago model, in which it would partner with or gain some level of ownership stake in an exchange. "For Archipelago, it's the Pacific [Stock Exchange], and for INET it would be Cincinatti [now known as NSX]. They'd be a facility of the Cincinatti Stock Exchange," the senior executive explains.

Because INET reports its trades in Nasdaq-listed stocks to the NSX and participates in a market-data revenue sharing program via NSX, Celent's Burns agrees that NSX is a likely candidate to team with INET. "I think there is more of a reason for INET to buy NSX than for NSX to buy INET," she says, noting that NSX is already an automated marketplace without a floor so it doesn't need INET to qualify as a fast market. Under Reg NMS' new market-data revenue allocation formula, however, NSX might need to partner with an ECN to maintain the market-data revenues it's currently earning. Today, INET reports its trades in Nasdaq stocks to NSX, but if a broker wants to see the orders quoted in INET's order book, the broker needs direct access to INET, not NSX.

But, that may need to change. Under Reg NMS, an exchange's quotes, as well as its trades, would count in the SEC's new market-data-revenue-allocation formula, so both quotes and trade reports will need to be available in the same place to qualify for tape revenues.

In response to the speculation about a possible merger with INET, David Colker, NSX's CEO, says only that the exchange is working very hard to keep INET's business. "We're talking about every angle," he says. "Arca [Archipelago] has bought an exchange; Nasdaq is basically an exchange. INET and NSX are a powerful combination. They need each other. We're working very hard to keep ourselves relevant." 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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