Introductory Remarks Robert A. Schwartz:
Ten years have passed since the market crash of October 19,
1987. I have been asked if I have timed this conference to coincide
with another crash. I guess we will find out. I have also been
asked if it can happen again. Of course it can. The markets
are fragile. Market structure issues are complex and subtle.
There is a lot about the markets that we do not know. But we
certainly know a lot more than we did ten years ago, and we
are starting to see some very meaningful, fundamental changes
in market structure.(1)
The important thing is to keep the markets from crashing due
to market technical reasons. The 1987 crash had a large technical
component to it. For one thing, there were no special procedures
for keeping the markets reasonably liquid or for discovering
appropriate share values in the chaotic conditions that existed
in those wild days of October 1987.
Since recovering from the crash in 1987, we have entered a
protracted bull market that we are still enjoying. Funds have
flown into equities and into equity funds at an unprecedented
rate. The U.S. is leading the world in the development of an
equity culture. The U.S. appetite for equities is reaching out
to markets around the world. And it ranges from large cap stocks
We have experienced the effect of opening the primary equity
markets to small cap companies. I will name a few that not so
many years ago were small: Microsoft, Intel, Cisco, Oracle,
and Dell. I could continue. No wonder Congress has been so interested
in the health of our secondary markets. These companies could
not have grown as they did if they had not had good access to
equity financing. Without a well-functioning secondary market
for trading shares, these companies would not have had this
In the ten years since the crash, The Nasdaq Stock MarketSM
has grown enormously. The share value of the Nasdaq®
-listed companies has grown from a total market cap of $451
billion on January 1, 1987, to $1.96 trillion on January 1,
1997. This has been of enormous benefit to investors. The growth
of the companies themselves has also benefited the U.S. economy
broadly. It is one reason why today we are enjoying protracted
growth, low unemployment, and low inflation.
Today's conference is focused on Nasdaq. Nasdaq has been the
number one breeding ground for small companies that have become
large. What has happened in the U.S. has been closely watched
in the rest of the world. Small cap markets largely patterned
after Nasdaq are being introduced around the world. Most notably,
the Nouveau Marché in Paris, the Neuer Markt in Germany,
The Nasdaq market came under particular scrutiny after the
1987 crash and in the past several years, and its market structure
is now being transformed. But it is not easy for a market to
change. The cost of technology is enormous. The cost of making
a mistake while changing market structure can be far greater.
Yet the landscape has been changing— rapidly, dramatically.
Consideration is being given to introducing new technologies
and additional trading modalities in the Nasdaq
The first panel in this conference will focus on the pressures
for change that have come from academia, buy-side investors,
competition from other markets, and government regulators. In
the second session, Dean Furbush will present Nasdaq’s response.
The next two panels will address two key issues: (i) the effect
of reform on capital formation and (ii) the future of the dealer
market. Al Berkeley will then deliver the keynote address.
We look forward to learning more today about plans that are
under consideration at Nasdaq. However, in many respects the
discussion will be broader. I am delighted that many who are
with us today are from exchange markets. You are here from the
American Stock Exchange, the Chicago Mercantile Exchange, the
Chicago Stock Exchange, the New York Stock Exchange, the Amsterdam
Stock Exchange, the Bolsa Mexicana, Deutsche Borse, Le Nouveau
Marché, the Stockholm Stock Exchange, and the Toronto
Let us step back for a moment and consider market structure
more broadly than any one market center. Since the 1970s, widespread
attention has been given to the structure of the U.S. securities
markets. Yet, important questions have remained unanswered:
Should we be concerned about order flow fragmenting? What are
the prospects for a black box trading system? Should transparency
be mandated? What role should regulation play?
These and similar issues have been debated for years without
resolution. Perhaps it is time to approach them in a different
way. I had suggested that the questions be asked differently
in remarks I made this past April at the Global Financial Policy
Forum in Washington, organized by the Center for Strategic and
International Studies and the Securities Traders Association.(3)
Because time is short, I would like right now to raise just
one of the seven questions raised in April: Is the bid-ask spread
the major execution cost of trading?
The answer is no, and perhaps we all know it, but we treat
it as if it is. Academicians and regulators have focused intently
on the spread as a cost of trading. The reason, I think, is
that we can see the spread and we can measure it. Nevertheless,
I alternatively believe that dislocations of the spread due
to market impact and to intra-day price volatility are far more
important than the size of the spread, per se. In our considerations
of market structure and regulation, we should shift our emphasis
from the size of the bid-ask spread to the accuracy of price
discovery (the location of the spread). This reorientation is
important, regardless of the market center being considered.
Let us now turn our focus to Nasdaq and to the steps this market
is taking. I first call on my good friend and co-author to say
a few words. Bob Wood.
Robert A. Wood:
We live in an incredibly interesting period characterized by
an ever-rising rate of technological development. Instability
continually increases with the rapid development of communication
networks. It is easier to find the other side of the trade and
hence the need for intermediary services is diminishing. The
rules are changing rapidly, but the good news is that the trading
volume is exploding. How can market centers survive and even
flourish in this unstable environment? Can a dealer market survive
if its customers are permitted to post limit orders against
It seems we’re heading in the direction of multiple competing
trading venues, rather than the implicit design of the 1975
Securities Act. Fragmentation is a synonym for competition.
Now economic theory tells us that utility is maximized when
we permit competition to flourish, so market centers that encourage
and facilitate competition for order flow will fare the best.
Nasdaq has a second advantage at the moment. It has been subject
to enormous criticism in recent years and as a result has lowered
barriers to change. How can Nasdaq best facilitate competition?
One, Nasdaq should concentrate on maintaining the best possible
network and self-regulatory organization (SRO). Two, Nasdaq
should invite and encourage competition within and among trading
venues. Call markets should be used to open and close the Nasdaq
market. That would solve the nasty problem of the basis risk
for the Nasdaq 100 futures contract and provide many other benefits
to traders. Neither the U. S. Securities and Exchange Commission
(SEC), nor Nasdaq, should require system-wide trade-through
rules. Individual trading venues should be permitted to offer
separate price discovery to enhance the advantages of modularity,
although all must be linked with trade reporting. Nasdaq must
be circumspect about competing with those players it invites
onto its network. A conflict of interest arises when it competes
with its best customers, for example the central limit order
Will dealers be needed when the dust settles? Of course. We
will always be willing to pay someone to take the other side
of a trade when natural liquidity is not there and we are impatient.
days after the conference, on October 27, 1997, the market did
plunge 554 points.
(2) Since the
October conference, the NASD has had two announcements of particular
importance: an agreement in principle for a joint undertaking
with OptiMark Technologies (made in January 1998) and a proposed
merger with the American Stock Exchange (made in March 1998).
(3) I have subsequently
raised and discussed the seven questions in, "Where the
Rubber Meets the Road: Improving Portfolio Performance By Controlling
Trading Costs," The Journal of Performance Measurement,
by Dan Weaver and Robert A. Schwartz, Fall 1997, pp. 15-20.