There are the customers for trading access services and the
suppliers of trading access services. Harold Bradley, what are
I am a demanding customer, but I am a customer.
Buzzy Geduld, you are a supplier. Evan Schulman, Doug Atkin,
you are suppliers, definitely, and Steve Wunsch is a supplier
and George Jennison is a supplier.
What is the present status of the dealer market? The order
handling rules have narrowed the quotes and volume is up. What
has happened to payment for order flow?
There are lots of changes that have taken place and paying for
order flow is just one result. We have got limit orders, new
SEC fees, data processing costs, hardware, software and enormous
skyrocketing expenses because of all the new rules. There is
also the high cost of additional personnel because the new rules
are very demanding as far as manpower on the desk goes.
We are taking two steps back, needing a lot more physical bodies
on a desk. Because of all of those things, payment for order
flow has probably been slashed by more than 50 percent. That
is just one of the ripple effects.
Yes, it seems like payment for order flow is on its way out.
What about explicit commissions? Brokers are not charging explicit
commissions to institutions yet, but, how far behind can explicit
commissions be? How many dealers are there out there who are
willing to take limit orders with no commission?
I do not think the problem is how do you get a dealer to take
your order and put your order in front of his own proprietary
account. That is very simple. The question is, "Are you
willing to pay for it?" If someone has the opportunity
to turn a profit on a trade, not a guarantee and not even a
commission, I do not think there is a Market Maker in America
that is not happy to take your order.
The problem with the new rules is they have taken our ability
in many instances away to have that opportunity. When you say
to the customer, order 1,000 shares by buying at 10 and selling
at 10 and that is the law, I have no opportunity. On a not-held
order, I have an opportunity. And on those orders, I am going
to put your interest ahead of my interest. That is why I am
Why do firms list on Nasdaq? They list on Nasdaq because they
like to have the dealers market their firms. Why do they go
to the New York Stock Exchange? Well, it is good marketing too,
but a different sort.
Today, it is a good housekeeping seal of approval. If you list
on the New York Stock Exchange you have reached the pinnacle
in the United States of being a great company.
That is why people leave Nasdaq, in my opinion. It is viewed
as a step up.
People list for prestige reasons for the most part. If Nasdaq
can structure itself properly, then it will become the market
of choice, or if TradePoint, or Instinet, or if anybody else
out there does it, they will be the winners.
The challenge for Nasdaq is if you go to an "auction like"
market or to an order-driven market, you have gotten rid of
the biggest differentiator between your markets, leading with
the dealerization versus the auctionization vis-à-vis
your biggest competitor, the New York Stock Exchange. You are
at risk of losing Intel and Microsoft and all of these companies
to the premier order-driven stock exchange in the United States.
What is probably missing most from all of these discussions
is a recognition of how complicated this all is. Trying to design
a perfect market. Going back to Bill Lupien's comment this morning,
one size does not fit all. If we assume that one size does fit
all, the end result is that you wind up looking at each and
every piece of each and every market and trying to tear it apart
unless it conforms to the "National Market System."
Membership organizations have at their core a lot of pieces
of organizing principles that essentially look like restraints
of trade to the folks in the Antitrust Division of the Department
of Justice. If you take as your main goal to unwind those restraints
of trade, then you put in place auction market principles and
dealer markets. Order-driven systems, automated systems, order
handling rules that put the customer first.
The Nasdaq market is being imitated around the world because
of its great qualities, or success so far. Why is it that we
here are actually trying to tear it down? I would say it is
quite possible the dealer markets are springing up around the
world, not just because they are trying to imitate Nasdaq, but
because as successful capital raising, capitalism and economic
activity grow, dealer markets naturally spring up. If we are
now in the process of a regulatory squeezing down of that structure
that seems to naturally spring up when capitalism is successful,
we are headed toward a problem.
Can I suggest that part of what raises capital and part of what
makes capital formation in this country work, is confidence
in markets. Without a strong Nasdaq market, or New York Stock
Exchange, or American Stock Exchange, without those strong markets
you are not going to raise sixty billion, or two dollars and
fifty cents. The structure of the market is very important.
Let's talk about how things have changed at Instinet as a result
of the changes in the order handling rules. First, would a customer
of Instinet like to tell us about how Instinet trading has changed?
The order handling rules have made Instinet competitively vulnerable.
The rules allow for institutions that engage in trying to be
wholesalers to work large orders in small fashion and be part
of the public quote. That ability to advertise that trading
interest has been very effective for our firm and very healthy,
and we think it adds a lot of value for our shareholders.
Is Instinet more attractive to you, or less attractive to you
now that the order handling rules are in place?
The order handling rules make Instinet more attractive. They
allow for more ECNs to encroach on that same space. Instinet
was apart by itself and people went there because if they did
not go there they would miss something that traded. What the
order handling rules have done is basically say those quotes
are now part of the public market. People can go to Instinet
because it is now advertised in the public quote.
I have some serious concerns about capital formation. We were
a very early user and strong sponsor of the Instinet application
of the marketplace. We are probably still one of the larger
institutional users of that trading functionality. Over the
last couple of years, we have seen this kind of rush to ECNs.
The most eye-opening experience was going to a Nasdaq Quality
of Markets Committee meeting and being told that there were
six, or eight, or ten firms now functionally acting as Market
Makers that were ready to introduce their own ECNs.
Brand strategy says that if you have a market niche and you
have a product that is commoditized as trading now is in limit
order books, the only way to build your product is to provide
better and more efficient distribution, technology, product
packaging, and to do it at lower cost. You cannot do one or
the other, you have got to do them all.
We now have a dominant player, Instinet, that has taken 25
percent of the revenues out of the pockets of the Nasdaq community
that underwrites stocks. It brings stocks public and it does
proprietary research on stocks. It also provided the more efficient
secondary market trading function.
The exchanges have existed to represent the collective economic
interests of their members. This way we do not have 18 market-making
firms spending $50 million a piece to create exactly the same
machine functionality mechanism. I think that is not good for
the capital markets. I do not think that is good for my shareholders.
Nasdaq is a delivery system. It is a place where I can expose
my bid and offering. In fact, I would raise the question, when
has the government, or any government agency, ever done an effective
job running any business?
Why would we want to have an SRO as our competitor? This is
exactly what a limit order book is going to do. You are going
to be in competition with me and every other dealer for that
order flow that we need to survive. You talk about narrowing
our profit margins. This is going to take some real gravy out
of our business. I do not think that is what an SRO is for.
What if they were not an SRO, Buzzy?
Then they could compete with me and I have no problem with that.
Right now Instinet is my competitor. Instinet is vying for that
same order flow.
Say you went to a central market and got paid for the volume
you brought and you were a dominant volume player. You would
not feel good about that?
If I happen to end up being the dominant Market Maker of course
I would, but the truth of the matter is, I do not think that
that is a level playing field for a number of reasons. The fact
is, it is almost government sanctioned. The person that has
an order to give out is going to feel much more comfortable.
He is not going to be criticized. Maybe he put it in the wrong
spot, the right spot. He is giving it to the NASD and I do not
think that is real competition. That is going to kill competition.
That will drive Market Makers out of the game.
The whole idea about bringing ECNs into an exchange format is
because the NASD does not have the systems to track the audit
trail. The best audit trails that exist are in the ECNs. They
can track every cancel, every replacement, every trade, everyone
who is in, who is out, at any time. Maybe it is time to separate
the SRO from the competitive market function.
I was present when Nasdaq was founded. I was on the board of
the NASD and I said that the NASD should not start Nasdaq because
it should not operate a money-making business. It should be
a self-regulator and nothing else. I could not get a second
for my motion. I would like to try to make that motion today.
Does the industry really need, and can it afford, to have a
whole bunch of self-regulators with the same members belonging
to many of them? Or should there be a self-regulatory agency
that deals with the issues? Market centers including the New
York Stock Exchange, the American Stock Exchange, and The Nasdaq
Stock Market should become competitive, independent market centers,
competing evenly with the Instinets and the OptiMarks and the
rest of the market centers. This is the model we should be looking
toward as we hit the new millennium.
Steve, could we have a few words from you on where you think
the dealer market is going from here?
That is almost impossible to say. If you look at the way people
define dealer markets around the world, be it in stocks, currencies,
or bonds, you find markets that have very attractive properties
of liquidity and associations with capital raising.
In this country we have been able to actually create a market
like that for stocks, and small stocks in particular, that is
potentially very valuable. I do not know to what degree the
dealer market, or the dealers themselves, are going to be able
to find their way around these reforms, new rules, and new regimes.
It is unfortunate in any case that it has become an official
regulatory policy to eliminate the structure that most people
would currently associate with a dealer market. I would note
that it is not something that is just happening in the United
States. You can look around at the introduction of order-driven
markets in Europe, London, and virtually everywhere else.
You can find that wherever dealer markets have been springing
up and succeeding, in response to successful capital raising,
there are movements to eliminate them. That is a potentially
dangerous development. It is a little frightening to see that
it has become official policy to stop what has been happening,
since it has been so successful.
Evan Schulman, where do you think the dealer market is going?
The question has been asked several times during this panel,
"What is Nasdaq now?" I view Nasdaq as having three
features that bear on its future. It is a market in which stock
is moved from one investor to another through one or more intermediaries.
These intermediaries require risk capital to transition their
inventories through time. I come from an old-fashioned background
that expects capital to be used to create physical goods like
trucks, planes, plants, and equipment. These things have a real
use: employing scarce capital simply to alter the indicia of
ownership among well-capitalized investors appears to be a misuse
of capital. It would be nice if we could conserve the use of
Secondly, given that the dealer is the immediate contra-party
to any institutional order, the question arises as to how the
institutional trader gets the dealer to act in the best interest
of the beneficial owners of the assets? Wags capture the essence
of this problem with the saying that "your first call is
your most expensive call." Also the fact that the SEC recently
issued a set of order handling rules for this dealer market
implies that we have not been altogether successful in dealing
with the agency problem.
Thirdly, the NASD controls Nasdaq. The largest dealers influence
this body. Those with vested interest in the current system
are unlikely to change it from within. We need to separate rule
making from ownership. Again, I refer to the order handling
rules: this is change from without.
If we cannot separate rule making from ownership, it is unlikely
that we will see much change in dealing with agency problems
or conserving capital. Thus, if we cannot separate rule making
from ownership, my forecast is that there will be no significant
change in Nasdaq until a new market arises to compete for the
listings and order flow. My expectation is that agency electronic
systems will arise in the future. They may run on, or under,
the Nasdaq shell, but the technology employed and the functioning
of those markets will be different to that of our current dealer-based,
stock specific, quote-driven market.
George, do you have a few words for us on the future of the
One of the offshoots of the new order handling rules has been
that we can get rid of the telephones on the trading desk. We
do not need them anymore. That bothers me a little because at
some point, what we are really all concerned about, and what
the accounts and our customers really care about, is liquidity.
Issuers also care about liquidity in their stocks, as well in
an orderly market.
Doug, would you sum things up for us?
Markets are adjusting mainly to two things. The business practice
changes that have taken place amongst the main stake holders,
the institutions, the members, and the exchanges themselves,
as well as the convergence of these participants. Everyone is
starting to look more and more the same and that is pretty healthy.
It has been an evolution, not a revolution and it has been healthy
for the market.
In particular, the rising of institutional influence has been
an important factor in some of the changes in the marketplace.
In that context, Nasdaq in some ways has taken a bad rap when
you set it against its competitors in the United States and
other stock exchanges around the world. All markets are trying
to come to terms with the changes in business practice.
All good markets must have a negotiated component, as well
as an options component. It is a fact. You must give clients
the ability to negotiate stocks upstairs through capital committing
firms or agency firms.
The larger challenge is for the members of Nasdaq, Instinet
being one of them. Clients are demanding better access. They
are demanding two things if you make this simple. Better access
to the markets and more information from the markets.
What do you think the Nasdaq market will come to look like,
Change is tough. It is always tough. We are afraid of change.
It is something different, it is something new. But the rules
are here and what the market might look like in the future will
probably be a hybrid market. It is going to be part auction,
part negotiated. Some people are going to pay fees depending
on what kind of a client they are. Some people are going to
pay commissions. Some people are still going to have net trades.
We will get electronic access because we, as dealers, are going
to need that to liquefy our positions. That is going to be a
big change. Capital allocation will be something that every
firm is going to examine.
Susan Woodward: Harold, do you have a few last words
for us on the future of the dealer market?
With what the rules have done this year, I am extremely excited
about the future of the dealer market. Dealer capital is very,
from Junius W. Peake, Monfort Distinguished Professor of Finance,
University of Northern Colorado, were made from the floor.