What is it about the floor - the history, the frenzy, the money, the legacy? Whatever it is, the NYSE floor, as it stands today, is under threat - and not just from dissatisfied institutional investors, but also from market restructuring proposals from the SEC and the NYSE's own plan to create a hybrid market.
But why are investors unhappy? What is it about the floor that drives large investors nuts? Buy-side traders complain about not being able to get the advertised price; they criticize the process of hitting a bid (or lifting an offer) and watching the price move against them; and they say that decimalization has increased market impact, making it more difficult to trade.
Conversely, floor brokers and specialists say that the broker-specialist relationship enables better price discovery, facilitates greater liquidity, provides enhanced price improvement and is a better way to trade.
So who's right? The problem is, they both are. The floor is a very good mechanism for discovering price and finding liquidity. If you look at the statistics, the NYSE provides tighter spreads, more reliable execution and better price improvement. But what's the rub?
The basic problem seems to be control and perception. The NYSE is a closed environment. While floor brokers provide "looks" (floor information) and the NYSE provides "open book" (outstanding limit orders), off-floor traders find transparency murky at best. This compares with the almost fully disclosed and accessible liquidity of OTC stocks traded by ECNs and market makers through direct-market-access (DMA) providers.
While Nasdaq and ECNs have hidden reserves and may not provide the liquidity or price improvement of the NYSE, institutional investors seem to have an easier time trading OTC shares than listed shares. This, I believe, is because institutional investors, through DMA technologies, have more control over the execution. Consolidated order books, smart order routing and the ability to get immediate execution - in addition to the ability to hide and tap into hidden reserves, sweep consolidated order books and take advantage of advanced order types such as pegged and contingent orders - provide investors with more control over their executions.
In other words, DMA provides investors with control. While this may not give the institutional investor the best price, or the most certain execution, it gives the investor more ownership of, and transparency into, the trade.
This was not always true. Before DMA, ECNs, decimalization and the SEC's 1997 Order Handling Rules, the OTC market was less transparent and far from efficient. It was mediated by market markers; electronic execution did not exist; and it was known for its collusive, rather than transparent, nature. Sound familiar?
So what will happen? Even with both the SEC and the NYSE pushing an electronic agenda, folks on the floor believe that they have the best model and, unless change is mandated, the status quo will remain.
While there is a future for the NYSE, big change is inevitable. Technology decentralizes control. Though floor people say their model is better, decimalization has led to cost reduction, which has led to algorithms and DMA. This has given the investor more control, leading to smaller and more electronic orders. And this trend shows no signs of abatement.
Are we better off? In some cases, yes; in others, no. But there is no turning back. Even if we are disadvantaged, people want control. Even though the NYSE is armed with execution-quality and liquidity statistics, institutional investors cherish certainty, speed and control over price, as the price of "what if" to the institutional investor will always be higher than the price of "now."
Larry Tabb is founder and CEO of Westborough, Mass.-based The Tabb Group, a financial-markets strategic-advisory firm. [email protected]Larry Tabb is the founder and CEO of TABB Group, the financial markets' research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on the interview-based research methodology of "first-person knowledge" he developed, TABB Group ... View Full Bio