1. The impact of Electronic Communications Networks (ECNs) on NYSE
Presentation to
Mr. Richard Grasso and
NYSE Directors

2. Agenda ECNs – What they are / History and growth
Strengths and Challenges
Threats to NYSE
Takeaways
Questions

3. History and Growth
Instinet, the first ECN, was created
Increased technology allows for greater capacity and efficiency
SEC Order Handling Rules triggers growth
1969
1970
1990
1996
2001 9
# ECNs 1

4. ECNs have 30% of trading volume in Nasdaq
REDIbook
Archipelago
ECNs
30%
Others
Instinet
70%
Island
Source: CSFB report

5. ECNs - What they are
Bring buyers and sellers together for electronic execution of trades.
Have a wide variety of subscribers, including retail investors, institutional investors, market makers and broker- dealers.
Allows subscribers to trade between themselves without having to go through a middleman
Are alternative to formal Stock Exchanges (NYSE) or to dealer makers (NASDAQ) for trading securities

6. How NYSE and ECN Transactions Differ
Own Inventory
Investor
Brokerage firm A
Specialist
IT System
Brokerage firm B
ECN
ECN
Investor

7. Limited orders

8. Strengths of ECNs Anonymity (Signaling) Commission Structure
Information leakage is greatly reduced
Commission Structure
Reduced from $.06 to $.03 per share
More efficient (Speed)
Orders post instantly versus wait up to three minutes
Neutrality
Removes conflicts of interest in trading for own accounts

9. Strengths of ECNs (cont.)
Transparency
ECNs post size and price of customer orders
After hours trading
ECNs offer an attractive venue for trading outside normal trading hours

10. The Challenges Facing ECNs
Liquidity
How to retain and attract volume
The greater the volume of transactions, the more likely trades will be executed successfully
Routing trades to other ECNs
Partnering with brokerage firms for order flow
Differentiation
An exchange that provides superior transaction processing
Or a value-added broker that offers a range of products

11. The Challenges Facing ECNs (cont.)
Increased Regulatory and Compliance Demands
Regulation ATS (Alternative Trading Systems)
SEC Broker Dealer Regulations
Exchange Specific Regulations
Integrity
Building an ethical reputation
Excelling in treatment of customers
Technology
Continual upgrade requires substantial investments

12. Why ECNs have had limited impact on NYSE
Reluctance of traders to change trading places
Better economies of scale through larger volumes per orders
Better liquidity
Automation of trading posts
NYSE Direct + (limited orders
smaller than 1,099 shares)

13. Threats to NYSE ECNs are merging to obtain benefits of network effects
If they are able to differentiate they can obtain
Market share
Profits inequality

14. The power of automation
Threats to NYSE
Full automation of NYSE would cut trading costs and reduce cost of capital to firms
Cost Reduction
Trading
Cost of capital
The power of automation
27 %
4.2 %
Source: The Economist

15. Threats to NYSE Exchanges around the world are merging
Achieve economies of scale
Get order flow to increase liquidity
Reduce fragmentation
Improve automation
Eg.
London Stock Exchange + Deustche Börse = iX
iX has signed a JV with Nasdaq

16. Threats to NYSE
Archipelago has obtained approval to become first ECN-based national stock exchange
Participants can trade NYSE, AMEX listed stocks, as well as Nasdaq shares
Archipelago can connect with other exchanges through the Intermarket Trading System and collect fees for data access

17. Takeaways ECNs have consistently increased volume share
ECNs have made inroads into the Nasdaq and into the European market
ECNs are changing the way that security markets conduct business
NYSE has remained the dominant player but will need to address its own capabilities to remain the market leader

18. Questions?

19. Supporting material

20. Market capitalization has increased at the NYSE…
NYSE business
Market capitalization has increased at the NYSE…
# companies listed = 2,800
Market Capitalization ($trillion)
# companies listed = 1,769
Source: The Economist

21. … and so has the American passion for equities
NYSE business
… and so has the American passion for equities %
% of adult population that owns shares
Source: The Economist

22. … however, ECNs can present a threat to NYSE
NYSE business
The automation of trading posts in 1999 has brought substantial benefits to the NYSE …
Increased volume
Additional sources of market information for specialists and brokers
Better visibility to institutions and investors
Enhanced liquidity
… however, ECNs can present a threat to NYSE

23. How ECNs operate with Nasdaq
Who are the ECNs and which services they provide
How ECNs operate with Nasdaq
Subscriber
Non Subscriber
Non Subscriber
Subscriber
Subscriber
Nasdaq
SelectNet
ECN
Non Subscriber
Non Subscriber
Non Subscribers access ECNs via SelectNet

24. Daily volume (in $Billion)
Trends and Threats
In 1986 London Stock Exchange introduced a screen-based quotation system (SEAQ)
Daily volume (in $Billion)
LSE
NYSE
Big Bang

25. Attachment 1 - Automation of Trading posts
Post Information displays
Flat panel display screen
Point-of-sale workstation
Wireless data system

26. Attachment 2 - The network effect
# of firms
Sales of largest q1
Sales of second q2
Sales of third q3
Profits of largest p1
Profits of second firm p2
Profits of third firm p3 1
0.6666 -
0.2222 2
0.6357
0.2428
0.1726
0.0294 3
0.6340
0.2326
0.0888
0.0231
Source: The impact of the Internet on financial markets - Nicholas Economides