UBS, Goldman Threaten NYSE, Nasdaq With Rival Stock Markets
Dec. 4 (Bloomberg) -- The biggest customers of the New York Stock Exchange and Nasdaq Stock Market are turning into their most dangerous competitors.
Securities firms, led by UBS AG, Goldman Sachs Group Inc. and Credit Suisse Group, already steer 12 percent of U.S. stock trades away from the exchanges to their internal systems. That share probably will increase to 18 percent by 2010 as more investment banks bypass the NYSE and Nasdaq and pair buyers and sellers of stock themselves, according to data compiled by Boston-based Aite Group LLC, a brokerage-industry consultant.
Now that computers have eliminated the need for trading floors like the Big Board's, the balance of power in equity markets is shifting. By bringing more orders in-house, where clients can move big blocks of stock anonymously, brokers pay the exchanges less in fees and capture a bigger share of the $11 billion a year that institutional investors pay in trading commissions.
``More internal flow gives you a bigger chance to get more trades for your customer or for yourself,'' said Larry Leibowitz, 46, UBS's chief operating officer for U.S. equities in Stamford, Connecticut. ``Less transparency could increase the value of the liquidity that a broker has since nobody else can see it.''
Because most bids and offers are shown on the NYSE and Nasdaq, trading on either exchange is akin to playing poker with an open hand. That's why money managers who don't want to expose their strategies are sending more trades to so-called dark pools, the internal or private networks where prices are secret.
Computer-Driven Trading
Evergreen Investment Management Co., which oversees $258 billion for clients, uses computer-driven algorithms to automatically pick the routes for as much as 15 percent of its orders, said Bob O'Brien, head of equity trading at the Boston- based firm. As a result, many never reach the NYSE or Nasdaq.
``We have a lot of the tools now to access the different pools of liquidity,'' O'Brien said. ``In the past, there was the concern that you would have to send an order in 20 different directions to tap into all the liquidity available.''
Aite Group estimates that algorithmic trading, which disguises orders to buy stocks at the best-possible prices on multiple markets, will account for more than 50 percent of all shares that change hands in the U.S. by 2010, up from about a third today.
Almost every major Wall Street firm operates an electronic- trading system that takes incoming trades from clients and tries to find a match internally before turning to other brokers, electronic networks or the exchanges. Zurich-based UBS, Europe's biggest bank, calls it Direct Strategy Access. Goldman's answer is REDIPlus. Morgan Stanley has Passport and Lehman Brothers Holdings Inc. calls it simply Electronic Trading Services.
Dark Pools
Credit Suisse, Switzerland's second-biggest bank after UBS, operates one of the largest dark pools, called CrossFinder, said Sandler O'Neill & Partners analyst Richard Repetto. Instead of building its own system to offer clients anonymous block trades, Merrill Lynch & Co. formed a joint venture with New York's Investment Technology Group Inc., whose 19-year-old Posit system was one of the first dark pools.
``They want to internalize that order flow and create a market center that you need representation in by using them as a broker,'' said Scott Thornton, head of equity trading at Los Angeles-based TCW Group, which oversees $137 billion. ``It helps their cost structure and gives them a competitive advantage.''
For every trade they match off the NYSE, brokers save 2.75 cents per 100 shares, or about 1 percent of the average commission on a stock trade. Last week, the NYSE raised transaction fees from 2.5 cents per 100 shares and eliminated a $750,000 monthly cap.
Rising Fees
As a result, Goldman, the biggest trader on the Big Board, faces an annual bill of about $20 million in NYSE transaction fees, based on its average volume for the first 11 months of the year. Under the old cap, Goldman paid a maximum of $9 million.
At current rates, the top stock brokers by volume -- UBS, Goldman, Morgan Stanley, Merrill and Lehman -- will pay about $90 million a year to the NYSE and Nasdaq, based on trading data reported by the exchanges.
``You are going to be more profitable if you have your own internal pool of liquidity to take a bid or an offer in milliseconds without going to the exchanges,'' said David Mortimer, former head of algorithmic trading at Piper Jaffray Cos. who's now a principal at Vodia Group LLC, an industry consulting firm in Concord, Massachusetts. ``You're getting paid something for the trade, instead of paying the exchanges, and you're faster than anybody else. What better way to lower your execution costs for proprietary trading?''
Accelerating Shift
Goldman, Morgan Stanley, Merrill, Lehman and Bear Stearns Cos., the five largest New York-based securities firms by market value, reported a 47 percent increase in combined revenue from equities trading to $20.3 billion in the first nine months of fiscal 2006. Stock trading accounted for 21 percent of total revenue, up from 19 percent in fiscal 2005, company reports show.
While Nasdaq and NYSE Group Inc., owner of the New York Stock Exchange, complete about 75 percent of the almost 5 billion shares a day that change hands in the U.S, their dominance is slipping. In October, securities firms ``internalized'' 16 percent of all trades in NYSE-listed stocks, up from 13.2 percent a year earlier and 11.5 percent in October 2004, according to data they reported to Nasdaq.
The shift accelerated after the NYSE acquired Chicago-based Archipelago Holdings Inc. in March, becoming a for-profit company and gaining the all-electronic Arca exchange. The advent of computerized trading forced the Big Board to give up the advantage it once held when all orders for NYSE-listed stocks went through its Lower Manhattan trading floor. In October, the exchange lifted restrictions on electronic orders and automated many of the tasks performed by its 2,500 traders.
Tables Turned
Bloomberg Tradebook, a unit of Bloomberg LP, the parent of Bloomberg News, and closely held markets such as Liquidnet Holdings Inc. also compete with the exchanges and with Wall Street for stock orders.
Three years ago, before the controversy over former Chairman Richard Grasso's pay forced the NYSE to overhaul its corporate governance, the chief executive officers of New York's largest firms, including Merrill's Stanley O'Neal and Goldman's Henry Paulson, were on the exchange's board. Now, they're taking business away from the NYSE.
In Europe, Citigroup, Goldman, Deutsche Bank AG, Merrill, UBS, Morgan Stanley and Credit Suisse said on Nov. 15 that they're forming a continent-wide equity trading platform to challenge traditional bourses such as London Stock Exchange Group Plc and Euronext NV.
Risks to NYSE
NYSE Group CEO John Thain, 51, a former Goldman president, addressed the Wall Street threat in comments Oct. 3 to reporters at the Foreign Press Center. Thain, 51, was unavailable to comment for this story, said spokesman Richard Adamonis.
``The increasing number of trading venues, as well as internalization, are the two main risks,'' he said. ``So far the dark pools haven't provided that much liquidity, but they're growing. There are today probably 20 places where you can send an order for New York Stock Exchange-listed stocks.''
Investors still consider NYSE Group's prospects good -- the company's shares have gained 50 percent since it went public by acquiring Archipelago in March. Even though the exchange is losing some business to the securities firms, it's benefiting from an industrywide surge in equity trading and Thain's push to get into new, faster-growing markets.
Surge in Trading
Trading volume at NYSE Group rose 13 percent in the past 12 months to 2.3 billion shares a day and JPMorgan Chase & Co. analyst Ken Worthington expects the exchange's new fees to fuel earnings growth. The number of options contracts traded on the NYSE Arca electronic market climbed 44 percent in the same period.
Thain also is poised to complete the $13.9 billion purchase of Paris-based Euronext, creating the first transatlantic stock market and strengthening the Big Board's allure as a listing venue for the world's largest companies. The acquisition also would make NYSE Group the owner of Euronext.Liffe, Europe's second-largest futures market.
Nasdaq CEO Robert Greifeld, 49, also is trying to expand overseas. Last month, New York-based Nasdaq offered to buy the 71.3 percent in London Stock Exchange it doesn't already own for about 1.89 billion pounds ($3.7 billion.)
At Nasdaq, which has been all-electronic since its founding in 1971, the percentage of internalized trades has remained steady at about 30 percent over the past two years because there's no barrier for brokers to compete on equal footing with the exchange.
Reclaiming Orders
While the practice of internalization, or filling one client's order to buy shares with another's to sell, dates back to the NYSE's founding in 1792, it's growing more popular as fund managers hold larger blocks of stock. Anonymous trades on systems where all orders are handled off the exchanges allow such investors to buy and sell quickly, without causing a move in prices that can cut the profit or exacerbate the loss, said Michael Bleich, Lehman's head of liquidity strategy.
``It's an attempt by brokers to reclaim their order flow,'' said Bill Harts, 50, head of strategy for equity trading at Banc of America Securities in New York and a former Nasdaq executive. ``If people want to trade with them, and they can maximize the value of that trade and fulfill their best-execution requirements, why wouldn't they do it?''
`Forensic Trading'
Algorithmic trading and the use of dark pools has become so popular that Themis Trading LLC, an eight-broker firm in Chatham, New Jersey, makes a business of piecing those orders back together so clients have a better idea when to buy or sell stocks.
``We call it forensic trading because you have to dig through to figure out how a trade happened,'' said co-founder Joe Saluzzi, former head of sales at Instinet, an electronic brokerage bought by Japan's Nomura Holdings Inc. ``We see this all the time now, where trades are happening in multiple venues.''
The lack of transparency is a growing concern for the U.S. Securities and Exchange Commission, which in 2004 passed rules requiring that trades be done at the best electronic price available and that brokers accounting for 5 percent of the volume in a stock offer public access to their markets. The agency has since granted some brokerages, such as Liquidnet, exemptions from the fair-access rule and it's currently weighing their impact on public markets.
Role of Algorithms
At Credit Suisse, all outbound orders go through its CrossFinder electronic market, where they can be matched with the bank's other customers. Algorithms probe other markets to check if better prices are available elsewhere before the trade is completed.
``In the old days, you could look at publicly displayed liquidity, but now so much of it is dark that we feel algorithms should always look for the better offers for our clients,'' said Dan Mathisson, managing director and head of Credit Suisse's Advanced Execution Services in New York.
NYSE and Nasdaq face another threat from Wall Street. Most of the firms that focus on internalization to boost profits in equity trading have spent more than $160 million combined to acquire stakes in rival exchanges in the past two years.
Goldman, Bank of America Corp. of Charlotte, North Carolina, Bear Stearns and New York-based E*Trade Financial Corp. invested $20 million in the Chicago Stock Exchange in June. The next month, UBS, Merrill, Morgan Stanley, New York-based Citigroup Inc., Credit Suisse and hedge fund Citadel Investment Group LLC doubled their holding of the Philadelphia Stock Exchange to almost 90 percent.
Investments in Exchanges
Morgan Stanley and Credit Suisse in October bought stakes in Bats Trading Inc., an electronic stock market that was already partly owned by Lehman. Bats, which began operating in January, now handles more than 3 percent of the trading in Nasdaq-listed stocks. Lehman, Merrill, Citigroup, Credit Suisse and Boston- based Fidelity Investments, the world's biggest mutual fund manager, have acquired 42 percent of the Boston Equities Exchange.
``With the NYSE and Nasdaq being so large, brokers are looking for competition to keep prices lower,'' said UBS's Leibowitz.
Dec. 4 (Bloomberg) -- The biggest customers of the New York Stock Exchange and Nasdaq Stock Market are turning into their most dangerous competitors.
Securities firms, led by UBS AG, Goldman Sachs Group Inc. and Credit Suisse Group, already steer 12 percent of U.S. stock trades away from the exchanges to their internal systems. That share probably will increase to 18 percent by 2010 as more investment banks bypass the NYSE and Nasdaq and pair buyers and sellers of stock themselves, according to data compiled by Boston-based Aite Group LLC, a brokerage-industry consultant.
Now that computers have eliminated the need for trading floors like the Big Board's, the balance of power in equity markets is shifting. By bringing more orders in-house, where clients can move big blocks of stock anonymously, brokers pay the exchanges less in fees and capture a bigger share of the $11 billion a year that institutional investors pay in trading commissions.
``More internal flow gives you a bigger chance to get more trades for your customer or for yourself,'' said Larry Leibowitz, 46, UBS's chief operating officer for U.S. equities in Stamford, Connecticut. ``Less transparency could increase the value of the liquidity that a broker has since nobody else can see it.''
Because most bids and offers are shown on the NYSE and Nasdaq, trading on either exchange is akin to playing poker with an open hand. That's why money managers who don't want to expose their strategies are sending more trades to so-called dark pools, the internal or private networks where prices are secret.
Computer-Driven Trading
Evergreen Investment Management Co., which oversees $258 billion for clients, uses computer-driven algorithms to automatically pick the routes for as much as 15 percent of its orders, said Bob O'Brien, head of equity trading at the Boston- based firm. As a result, many never reach the NYSE or Nasdaq.
``We have a lot of the tools now to access the different pools of liquidity,'' O'Brien said. ``In the past, there was the concern that you would have to send an order in 20 different directions to tap into all the liquidity available.''
Aite Group estimates that algorithmic trading, which disguises orders to buy stocks at the best-possible prices on multiple markets, will account for more than 50 percent of all shares that change hands in the U.S. by 2010, up from about a third today.
Almost every major Wall Street firm operates an electronic- trading system that takes incoming trades from clients and tries to find a match internally before turning to other brokers, electronic networks or the exchanges. Zurich-based UBS, Europe's biggest bank, calls it Direct Strategy Access. Goldman's answer is REDIPlus. Morgan Stanley has Passport and Lehman Brothers Holdings Inc. calls it simply Electronic Trading Services.
Dark Pools
Credit Suisse, Switzerland's second-biggest bank after UBS, operates one of the largest dark pools, called CrossFinder, said Sandler O'Neill & Partners analyst Richard Repetto. Instead of building its own system to offer clients anonymous block trades, Merrill Lynch & Co. formed a joint venture with New York's Investment Technology Group Inc., whose 19-year-old Posit system was one of the first dark pools.
``They want to internalize that order flow and create a market center that you need representation in by using them as a broker,'' said Scott Thornton, head of equity trading at Los Angeles-based TCW Group, which oversees $137 billion. ``It helps their cost structure and gives them a competitive advantage.''
For every trade they match off the NYSE, brokers save 2.75 cents per 100 shares, or about 1 percent of the average commission on a stock trade. Last week, the NYSE raised transaction fees from 2.5 cents per 100 shares and eliminated a $750,000 monthly cap.
Rising Fees
As a result, Goldman, the biggest trader on the Big Board, faces an annual bill of about $20 million in NYSE transaction fees, based on its average volume for the first 11 months of the year. Under the old cap, Goldman paid a maximum of $9 million.
At current rates, the top stock brokers by volume -- UBS, Goldman, Morgan Stanley, Merrill and Lehman -- will pay about $90 million a year to the NYSE and Nasdaq, based on trading data reported by the exchanges.
``You are going to be more profitable if you have your own internal pool of liquidity to take a bid or an offer in milliseconds without going to the exchanges,'' said David Mortimer, former head of algorithmic trading at Piper Jaffray Cos. who's now a principal at Vodia Group LLC, an industry consulting firm in Concord, Massachusetts. ``You're getting paid something for the trade, instead of paying the exchanges, and you're faster than anybody else. What better way to lower your execution costs for proprietary trading?''
Accelerating Shift
Goldman, Morgan Stanley, Merrill, Lehman and Bear Stearns Cos., the five largest New York-based securities firms by market value, reported a 47 percent increase in combined revenue from equities trading to $20.3 billion in the first nine months of fiscal 2006. Stock trading accounted for 21 percent of total revenue, up from 19 percent in fiscal 2005, company reports show.
While Nasdaq and NYSE Group Inc., owner of the New York Stock Exchange, complete about 75 percent of the almost 5 billion shares a day that change hands in the U.S, their dominance is slipping. In October, securities firms ``internalized'' 16 percent of all trades in NYSE-listed stocks, up from 13.2 percent a year earlier and 11.5 percent in October 2004, according to data they reported to Nasdaq.
The shift accelerated after the NYSE acquired Chicago-based Archipelago Holdings Inc. in March, becoming a for-profit company and gaining the all-electronic Arca exchange. The advent of computerized trading forced the Big Board to give up the advantage it once held when all orders for NYSE-listed stocks went through its Lower Manhattan trading floor. In October, the exchange lifted restrictions on electronic orders and automated many of the tasks performed by its 2,500 traders.
Tables Turned
Bloomberg Tradebook, a unit of Bloomberg LP, the parent of Bloomberg News, and closely held markets such as Liquidnet Holdings Inc. also compete with the exchanges and with Wall Street for stock orders.
Three years ago, before the controversy over former Chairman Richard Grasso's pay forced the NYSE to overhaul its corporate governance, the chief executive officers of New York's largest firms, including Merrill's Stanley O'Neal and Goldman's Henry Paulson, were on the exchange's board. Now, they're taking business away from the NYSE.
In Europe, Citigroup, Goldman, Deutsche Bank AG, Merrill, UBS, Morgan Stanley and Credit Suisse said on Nov. 15 that they're forming a continent-wide equity trading platform to challenge traditional bourses such as London Stock Exchange Group Plc and Euronext NV.
Risks to NYSE
NYSE Group CEO John Thain, 51, a former Goldman president, addressed the Wall Street threat in comments Oct. 3 to reporters at the Foreign Press Center. Thain, 51, was unavailable to comment for this story, said spokesman Richard Adamonis.
``The increasing number of trading venues, as well as internalization, are the two main risks,'' he said. ``So far the dark pools haven't provided that much liquidity, but they're growing. There are today probably 20 places where you can send an order for New York Stock Exchange-listed stocks.''
Investors still consider NYSE Group's prospects good -- the company's shares have gained 50 percent since it went public by acquiring Archipelago in March. Even though the exchange is losing some business to the securities firms, it's benefiting from an industrywide surge in equity trading and Thain's push to get into new, faster-growing markets.
Surge in Trading
Trading volume at NYSE Group rose 13 percent in the past 12 months to 2.3 billion shares a day and JPMorgan Chase & Co. analyst Ken Worthington expects the exchange's new fees to fuel earnings growth. The number of options contracts traded on the NYSE Arca electronic market climbed 44 percent in the same period.
Thain also is poised to complete the $13.9 billion purchase of Paris-based Euronext, creating the first transatlantic stock market and strengthening the Big Board's allure as a listing venue for the world's largest companies. The acquisition also would make NYSE Group the owner of Euronext.Liffe, Europe's second-largest futures market.
Nasdaq CEO Robert Greifeld, 49, also is trying to expand overseas. Last month, New York-based Nasdaq offered to buy the 71.3 percent in London Stock Exchange it doesn't already own for about 1.89 billion pounds ($3.7 billion.)
At Nasdaq, which has been all-electronic since its founding in 1971, the percentage of internalized trades has remained steady at about 30 percent over the past two years because there's no barrier for brokers to compete on equal footing with the exchange.
Reclaiming Orders
While the practice of internalization, or filling one client's order to buy shares with another's to sell, dates back to the NYSE's founding in 1792, it's growing more popular as fund managers hold larger blocks of stock. Anonymous trades on systems where all orders are handled off the exchanges allow such investors to buy and sell quickly, without causing a move in prices that can cut the profit or exacerbate the loss, said Michael Bleich, Lehman's head of liquidity strategy.
``It's an attempt by brokers to reclaim their order flow,'' said Bill Harts, 50, head of strategy for equity trading at Banc of America Securities in New York and a former Nasdaq executive. ``If people want to trade with them, and they can maximize the value of that trade and fulfill their best-execution requirements, why wouldn't they do it?''
`Forensic Trading'
Algorithmic trading and the use of dark pools has become so popular that Themis Trading LLC, an eight-broker firm in Chatham, New Jersey, makes a business of piecing those orders back together so clients have a better idea when to buy or sell stocks.
``We call it forensic trading because you have to dig through to figure out how a trade happened,'' said co-founder Joe Saluzzi, former head of sales at Instinet, an electronic brokerage bought by Japan's Nomura Holdings Inc. ``We see this all the time now, where trades are happening in multiple venues.''
The lack of transparency is a growing concern for the U.S. Securities and Exchange Commission, which in 2004 passed rules requiring that trades be done at the best electronic price available and that brokers accounting for 5 percent of the volume in a stock offer public access to their markets. The agency has since granted some brokerages, such as Liquidnet, exemptions from the fair-access rule and it's currently weighing their impact on public markets.
Role of Algorithms
At Credit Suisse, all outbound orders go through its CrossFinder electronic market, where they can be matched with the bank's other customers. Algorithms probe other markets to check if better prices are available elsewhere before the trade is completed.
``In the old days, you could look at publicly displayed liquidity, but now so much of it is dark that we feel algorithms should always look for the better offers for our clients,'' said Dan Mathisson, managing director and head of Credit Suisse's Advanced Execution Services in New York.
NYSE and Nasdaq face another threat from Wall Street. Most of the firms that focus on internalization to boost profits in equity trading have spent more than $160 million combined to acquire stakes in rival exchanges in the past two years.
Goldman, Bank of America Corp. of Charlotte, North Carolina, Bear Stearns and New York-based E*Trade Financial Corp. invested $20 million in the Chicago Stock Exchange in June. The next month, UBS, Merrill, Morgan Stanley, New York-based Citigroup Inc., Credit Suisse and hedge fund Citadel Investment Group LLC doubled their holding of the Philadelphia Stock Exchange to almost 90 percent.
Investments in Exchanges
Morgan Stanley and Credit Suisse in October bought stakes in Bats Trading Inc., an electronic stock market that was already partly owned by Lehman. Bats, which began operating in January, now handles more than 3 percent of the trading in Nasdaq-listed stocks. Lehman, Merrill, Citigroup, Credit Suisse and Boston- based Fidelity Investments, the world's biggest mutual fund manager, have acquired 42 percent of the Boston Equities Exchange.
``With the NYSE and Nasdaq being so large, brokers are looking for competition to keep prices lower,'' said UBS's Leibowitz.