A funny thing is taking place in the financial world. Computer servers, sitting in cold, dark rooms in exotic places like Jersey City, are quietly chewing up status quo industries and stealing half their business. Two major stories last week underlined how much the online “matching” services are going to change the way we all do business.
First came the news that Instinet and Island, the two biggest online trading systems, are merging. These electronic communications networks, known as ECNs, match stock trades via servers. Each does roughly 11% or so of Nasdaq trading volume. Although they’ve only been around since 1996, ECNs in total now do half of all trading in Nasdaq shares.
At that point the Big Board could be profitably converted into a giant, themed brew pub.
The reason why is the same reason that travel companies like Travelocity and Expedia, and job sites like Monster and HotJobs, have been such a success: Computers can match buys and sells in 30 milliseconds and for 7/100th of a cent per share. Tough for a football field-sized room of well-paid and snappily dressed human traders to keep up with that.
Now the revolution has moved to the options business. An electronic options exchange, the International Securities Exchange, is unstoppable, claiming 23% of equity options in May 2002, up from 8% a year ago. That’s business lured from the notorious shouting pits of Chicago and the American Stock Exchange.
The same dynamics are churning in the credit business. Last week, Wal-Mart, Sears and Safeway got class-action status in their suit against Visa and MasterCard. They accuse the plastic companies of forcing retailers to accept their debit cards and pay painful 1.49% fees. Piling on, the Justice Department brought an antitrust suit against Visa/MasterCard’s 75% market share.
Why the sudden peevishness? Unlike credit (with 2% to 3% fees), a debit transaction simply matches up bank accounts — something that servers do almost instantly. What irritates Wal-Mart is that the cost for Visa per transaction is only a penny or two using the Automated Clearing House, the system for inter-bank clearing. The Fed is a member; so is Visa. Wal-Mart is not.
It’s going to get ugly for banks. In 1999, Visa balked at signing up small merchants who plugged into auction sites like eBay. These merchants couldn’t accept credit cards, a problem, and a Silicon Valley company called PayPal stepped into the breach. Since its kickoff in October 1999, it has snared 16 million account holders and 35% of eBay’s payments. That success comes despite efforts by Citibank, Well Fargo and eBay themselves to control online payments. That’s no chicken scratch for Citigroup. Last year, North American credit cards were its second-largest profit contributor, making $2 billion.
PayPal still must play by the banks’ rules — it accepts credit cards and issue ATM cards, and it’s glad to charge fees just under the existing players’ umbrella. But each time it can move money for two cents via ACH instead of for 2% via fee-grabbing banks, PayPal wins.
Not everyone likes this automation, and many are hiding behind the skirt of regulations. You might be thinking: If ECNs do half of all Nasdaq trades, why don’t they trade half the shares of the New York Stock Exchange, where their infiltration is still under 10%?
The rules say that if an ECN wants to do a trade of a NYSE stock, at a price inferior to the current price on the Big Board floor, it must first send down a request to the human specialist, called a “commitment to trade.” Prices are inferior all the time; the NYSE price may be stale; or for only 100 shares; or wrong on purpose to try to cross a block.
Either way, this so-called “trade through” rule allows the specialist 30 seconds to respond or he can just ignore the request. That’s 30 seconds vs. 30 milliseconds. A thousand trades can take place online before a human responds.
ECNs can’t afford the liability of specialists coming back and demanding payment for a trade, so ECNs don’t do them. But last Nov. 28, when Enron’s stock was halted at $3.60, ECNs matched 30 million Enron shares between $3 and $1.20 until the specialist opened it back up at $1.20.
Who needs him? Goldman Sachs and Fleet do; they own some 40% of the specialists between them. And, the NYSE does; it collects $160 million a year selling pricing data, and almost twice that in listing fees. If, however, the trade-through rule were to go away, ECNs would do half of NYSE volume within a few years. (It’s hard to collect fees when trades happen elsewhere). At that point the Big Board could be profitably converted into a giant, themed brew pub.
When all the strings and red tape are cut away, matching services have already proved they can quickly do half of transactions. It is going on right now, underneath the Street, and over time will make bear markets and accounting issues seem tame.
Mr. Kessler, a former hedge-fund manager, is writing a book on technology and markets.
ersjonen av den type for den klassiske rektangulært tverrsnitt i 1997.
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Posted by: Mulberry Vesker | September 13, 2012 at 11:54 PM