The New Big Board—Or Is That Screen?

One veteran UBS broker with a transaction bent loses no love over floor traders. Orders fill slowly and come in higher than the original offer, he says. So, when the deal merging Archipelago Holdings, the nation's first completely electronic stock market, with the New York Stock Exchange closes this month, he's anticipating better times ahead.

Despite its dominating presence in the equity trading market as the world's largest exchange, the NYSE is a dinosaur that shows it age every day, doing business the same way it's done it for 214 years. Archipelago, however, will take its heft and program it — the NYSE Group, as the combined firms will be known — into the future.

“The NYSE has 80 percent of the volume in NYSE-listed companies, but they know they can't hold onto that,” says John Coffee, a finance professor at Columbia University. “This is a way to get out of a declining business model and into growth mode.”

In the words of the man who orchestrated the deal, NYSE chief executive John Thain, the merger will create “a globally competitive, multiproduct marketplace.” By linking up with Archipelago, the NYSE gains a 25 percent share of trading in the over-the-counter market, gets the options business of the Pacific Stock Exchange and expands its product platform to include more ETFs and bonds, and, perhaps, foreign stocks, futures and derivatives later on.

The deal will enable the exchange to compete globally against richer and more nimble competitors like Germany's Deutsche Boerse (which is pursuing Euronext), as well as its primary competitor, NASDAQ, the world's second largest exchange. Only two days after the NYSE/Archipelago announcement, NASDAQ announced it had purchased the electronic trading network of Instinet Group, one of its chief rivals. The race to consolidate is on. Thain remarked last year in Davos, Switzerland, that the NYSE would like to lead the consolidation of the industry, particularly in Europe, and that it would be watching the Deutsche Boerse, the London Stock Exchange and other competitors for opportunities.

But the addition of Archipelago's all-electronic exchange means the NYSE acquires a much faster and cheaper way of filling orders. Computers will even audit themselves, improving transparency and the odds of reducing improper or illegal behavior.

Ironically, the NYSE had to do some housecleaning before it could work itself into a position to do the Archipelago deal. In 2003, former NYSE chairman Richard Grasso was kicked out for his $139.5 million pay package. Soon after, the exchange's specialists, who manage trading of the stocks, came under investigation by the SEC for cheating investors. A settlement was reached that required the NYSE to put in place a new corporate structure and hire new management, chiefly Thain. With a new chief aboard and the SEC in an amiable mood, the NYSE was primed for a big fresh start.

Bait and Switch?

Much more change is expected with the merger, but two centuries of history aren't likely to just disappear. Rather they will likely be wrenched away in chunks.

In the new organization, there will still be a trading floor filled with a cacophony of floor brokers and specialists. Yet along with the old auction model, the NYSE Group, pending SEC approval, will also have the Archipelago electronic platform and a “hybrid” market.

This hybrid market is intended to combine the auction system with the speed of electronic trading. Industry observers see the implementation of a “hybrid” market as a bait-and-switch scheme to win approval — 95 percent of the NYSE's 1,336 seat holders — for the merger.

“No other stock exchange has copied the floor model — they're all electronic,” says Junius Peake, a finance professor at the University of Northern Colorado. He says he foresees the hybrid model eventually falling flat on its face and the floor going out of business. Adds Peake: “The fact is you can trade any stock listed on the NYSE at Arca [Archipelago] or any of the other ECNs [electronic communication networks] that has access to NYSE.”

The problem with the hybrid as any kind of best-of-both worlds is that, as Peake says, it's too complicated. He challenges anyone to read the 85-page document of diagrams and text on the NYSE Web site that explains how “27 different transaction types would be executed in a hybrid-market environment.”

Gus Sauter, the chief investment officer of Vanguard, agrees that the days of the floor are likely numbered. “I think there's no question institutional traders are moving to electronic trading,” says Sauter. He estimates that Vanguard does nearly 85 percent of its trades electronically. “We like being able to meet the other side without intermediation whenever possible,” he says. He also says the role of the traditional market maker — to provide liquidity — has diminished significantly because the markets are getting so much liquidity already.

For brokers like the transaction-oriented UBS veteran, there's the hope that Archipelago's influence will lead to better prices sooner rather than later. It will certainly bring faster reporting times for trades after the merger is complete. It will give him peace of mind, too. Insists the veteran: “Computers will always give me better execution than the open outcry.”