ECN`s

ELECTRONIC COMMUNICATION
NETWORKS (ECN’s)
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Dr. Allan E. Young
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Professor of Finance
Syracuse University, School of Management
Editor-in-Chief,
Journal of Entrepreneurial Finance and Business
Ventures
ECN’s – SEC Definitional Features
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ECNs, are electronic trading systems that automatically
match buy and sell orders at specified prices.
ECNs register with the SEC as broker-dealers.
Those who subscribe to ECNs – institutional investors,
broker-dealers, and market-makers – can place trades
directly with an ECN.
Individual investors must currently have an account with a
broker-dealer subscriber before their orders can be routed
to an ECN for execution.
ECN’s – SEC Definitional Features
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When seeking to buy or sell securities, ECN
subscribers use limit orders.
ECNs post orders on their systems for other
subscribers to view. The ECN will then
automatically match orders for execution.
ECN – Trading Environment
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Source: EDS’ Global Financial Industry Group
ECN - Advantages
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Cost reduction – ECNs reduce and, in some instances
eliminate bid/ask spread. They also help to diminish market
impact cost.
Faster execution – Since the process is fully automated, an
order can be matched and confirmed faster. An investor will
receive immediate price and transaction confirmation.
Transparency – ECNs consolidate unfulfilled orders, thereby
providing a limit order book that improves the assessment of
actual demand.
Trade customization – ECNs provide customization of
trading preferences of buyers and sellers.
ECN – Advantages (contd.)
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Anonymous trading – ECNs protect confidentiality as any
transfer to conventional market makers is accomplished in a
"street name.”
After-hours trading – Through ECNs, off-exchange
electronic trading creates an after-hours market enabling
traders to better manage their positions and risk in a
globally independent economy.
Enablers of market expansion – ECNs provide easy
expansion into other markets and increasingly into
international markets.
ECN - Disadvantages
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Trading volumes – ECNs are most appropriate for wellknown companies with heavily traded stocks. Transactions
in smaller, more thinly traded issues, typically remain with
traditional market makers.
Disaster recovery and business continuity – ECNs have not
been fully tested in a high volume and volatile-trading
environment where business continuity/disaster recovery
facilities are invoked and/or tested.
Fragmentation – Trading of the same security can
simultaneously occur on multiple ECNs. Liquidity continues
to be an issue.
ECN – Disadvantages (contd.)
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Liquidity – Block-orders of shares in ECNs are much smaller
than the average block for the Dealer Market making it more
difficult to exit the market once an investor places a large
order.
Volatility – Increasing trades-volumes and fragmented
markets can cause market orders that do not represent the
real price of a stock. These orders are posted in the market
and can lead to volatile prices.
Regulatory issues – Many regulatory issues are becoming
more complex as ECNs enter the exchange and cross
border business.
Inability to improve prices – ECNs display and execute
orders to buy or sell within predefined limits only.
ECN’s – Volumes
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Source: NASDAQ and the Tower Group
ECN’s – Major Players
ECN
TYPE
Instinet
Public
Island
Subsidiary of Instinet
Archipelago Private
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COMMENTS
Major player with largest market share, mainly for Institutional Investors
Owns Island ECN
Ranks #2 in Volume
Very popular for active individual traders
Classifies itself as a "Stock Exchange" due to partnership with the
Pacific Stock Exchange
Owned by Goldman Sachs, E*Trade, JP Morgan, Southwest Securities
Redibook
Subsidiary of Archipelago
Strong partnerships eg. Charles Schwab, Fidelity
Strong technology advantage with Archipelago merger
BRUT
Subsidiary of SunGard Data Systems Relatively new on the ECN scene
Serves as a hybrid broker, stock exchange, and market maker
Owned by Goldman Sachs, Automated Securities Clearance,
Knight/Trimark Group, Merrill Lynch, Morgan Stanley Dean Witter
ECN’s – After Hours Trading
Electronic Communication Networks/ Brokerage Houses
Hours of Operation
(For Individual Investors)
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Market XT
6-8 p.m Eastern, Monday - Thursday
Datek Online (via Island ECN)
4-5:15 p.m Eastern
E*Trade (via Instinet ECN)
4-6:30 p.m Eastern
Schwab (via Redibook ECN)
4:30-7 p.m Eastern, Monday - Friday
DLJ Direct (via Redibook ECN)
8-9:15 a.m and 4:15-7 p.m Eastern
Fidelity Powerstreet (via Redibook ECN)
4:30-8 p.m Eastern.
Instinet
4-5:15 p.m
After Hours Trading - Risks
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Trading outside market hours might lead to increased price
volatility since fewer people will be trading during this time
frame.
ECNs only work well when there are plenty of buyers and
sellers who want to trade a specific stock. That means it can
be difficult to find a buyer for stocks that aren't well known.
ECNs only allow for "limit orders," or orders to buy a specific
number of shares of stocks at a specific price.
Only a limited number of stocks can be traded after hours.
This may frustrate investors, who prefer a broad selection.
After Hours Trading - Advantages
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Fair chance to all investors
Earlier, only institutional investors could trade on
news even as individual investors remained shut
out of the action. This was frustrating to many
individual investors since stocks can sometimes
rise or fall sharply in after-hours activity. Extending
trading hours for everyone enables all the players
to be on a level playing field.
After Hours Trading - Advantages
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Freedom for individual investors
Due to after hours trading individual investors are
not bound by time constraints. They can trade
whenever they want to. Especially for those
investors who are busy during the day, and are not
in a position to pay much attention to their portfolios.
After Hours Trading – Steps to Protect
Investors
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Know what the marketplace offers.
Some systems admit only individuals, while others are open
to institutions too. Likewise, not all stocks trade on all
systems.
Watch the order book.
An investors’ system’s order book shows each stock’s
current pricing information. An individual investor must
always keep an eye on them.
Name a price that is comfortable.
All after-hours orders are limit orders. An investor must
specify a price at which he or she will buy or sell.
After Hours Trading – Steps to Protect
Investors (contd.)
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Beware of market manipulation.
A market with few participants is easier to manipulate. An
individual investor must be alert and be wary of stocks that
are moving fast for no apparent reason.
Remember investment goals.
Every investor has a certain investment strategy based on
his or her investment goals. They should always be kept in
mind while trading. The reasons for buying or selling a stock
should be the same after hours as they are during the day.
Instinet – Selected Trading Data
U.S. Equity Shares Traded by
Instinet (1)
Month
Jan-03
Dec-02
Nov-02
Oct-02
Sep-02
Aug-02
Jul-02
Jun-02
May-02
Apr-02
Mar-02
Feb-02
17
Million shares
NASDAQ- Exchangelisted
listed
9,489
1,826
8,495
1,535
10,482
1,801
12,205
2,253
7,299
1,363
6,429
1,060
8,841
1,479
5,826
1,120
5,516
973
4,807
979
3,815
958
3,904
1,039
Total
U.S.
11,315
10,030
12,283
14,458
8,662
7,489
10,320
6,946
6,489
5,786
4,773
4,943
Market Share (Instinet (1)
volume as percent of total
market volume) (2)
%
NASDAQ- Exchange- Total
listed
listed
U.S.
29.1
4.4
15.3
28.8
4.4
15.5
28.9
4.6
16.3
31.0
4.6
16.3
24.7
3.7
13.1
19.3
2.7
10.3
18.7
2.8
10.3
15.9
2.8
9.1
13.6
2.9
8.8
12.3
2.8
7.8
10.8
2.9
6.9
11.3
3.2
7.4
Average Net Fee
Revenue per
U.S. Share
U.S. cents per
side per share
0.19
0.18
0.18
0.18
0.23
0.24
0.26
0.33
0.36
0.42
0.51
0.55
Instinet – Selected Trading Data
U.S. Equity Shares Traded by
Instinet (1)
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Month
Jan-02
Dec-01
Nov-01
Oct-01
Sep-01
Aug-01
Jul-01
Jun-01
May-01
Apr-01
Mar-01
Feb-01
Million shares
NASDAQ- Exchange- Total
listed
listed
U.S.
4,324
1,120
5,444
3,812
922
4,734
4,323
1,100
5,423
5,881
1,191
7,072
3,879
834
4,713
4,218
821
5,039
4,951
847
5,798
5,625
899
6,524
6,153
838
6,991
6,998
875
7,873
7,249
928
8,177
5,712
776
6,488
Market Share (Instinet (1)
volume as percent of total
market volume) (2)
%
NASDAQ- Exchange- Total
listed
listed
U.S.
10.9
3.0
7.1
10.6
2.9
7.0
11.2
3.3
7.6
13.3
3.3
8.7
12.7
2.9
7.9
12.9
3.0
8.4
14.9
3.1
9.6
14.9
3.2
9.9
14.7
3.0
9.9
16.2
3.0
10.9
15.9
2.9
10.5
15.4
3.1
10.5
Average Net Fee
Revenue per
U.S. Share
U.S. cents per
side per share
0.59
0.60
0.62
0.62
0.69
0.71
0.67
0.66
0.64
0.62
0.63
0.65
Instinet – Selected Trading Data
U.S. Equity Shares Traded by
Instinet (1)
Month
Jan-01
Dec-00
Nov-00
Oct-00
Sep-00
Aug-00
Jul-00
Jun-00
May-00
Apr-00
Mar-00
Feb-00
Average
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Million shares
NASDAQ- Exchange- Total
listed
listed
U.S.
7,092
985
8,077
5,931
859
6,790
5,513
814
6,327
6,375
1,008
7,383
4,679
803
5,482
4,221
840
5,061
4,172
757
4,929
4,302
821
5,123
4,382
748
5,130
4,961
708
5,669
5,007
753
5,760
3,769
576
4,345
5,851
1,034
6,885
Market Share (Instinet (1)
volume as percent of total
market volume) (2)
%
NASDAQ- Exchange- Total
listed
listed
U.S.
14.2
3.0
9.8
13.2
3.0
9.2
14.3
3.2
9.9
14.3
3.3
9.8
13.3
3.3
9.2
12.6
3.5
8.7
13.3
3.3
9.1
12.7
3.2
8.6
14.1
3.2
9.4
13.9
3.0
9.5
11.4
2.4
7.7
10.4
2.3
7.1
15.7
3.2
9.8
Average Net Fee
Revenue per
U.S. Share
U.S. cents per
side per share
0.67
0.67
0.70
0.69
0.75
0.76
0.77
0.77
0.76
0.75
0.80
0.77
0.56
Instinet – Selected Trading Data
Footnotes:
Monthly totals may not reflect weekly data, which are preliminary. The number of trading days in each period takes account of U.S.
market holidays and any other U.S. market closings.
1 Represents Instinet Group Incorporated volume from all sources, including the Island ECN beginning the week ended 9/27/02,
2 Market share information may be subject to change when NASDAQ posts its final volume statistics.
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ECN’s – Profitability of Instinet
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ECN’s – Profitability of Instinet
Instinet - Quarterly Financial Information
30-Sep-02
30-Jun-02
31-Mar-02
31-Dec-01
Total Revenue
$254,280,000 $261,718,000 $276,093,000 $350,323,000
Net Income/(Loss) ($528,439,000) ($59,905,000) ($34,683,000) $45,719,000
$400
$350
$300
$250
$200
$150
$100
$50
$0
$100
Dec-01
Mar-02
Jun-02
Quarters
Revenues
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Net Income
Net Income ($ million)
Revenues ($ million)
Total Revenues
Sep-02
$0
($100) Dec-01
Mar-02
Jun-02
($200)
($300)
($400)
($500)
($600)
Quarters
Net Income
Sep-02
Island – Selected Trading Data
Island's Average Daily
U.S. Equity Shares
Traded (ADV)
(million shares)
Week
Ended
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2/28/2003
2/21/2003
2/14/2003
2/7/2003
1/31/2003
1/24/2003
1/17/2003
1/10/2003
1/3/2003
12/27/2002
12/20/2002
12/13/2002
12/6/2002
# Trade
Days
5
4
5
5
5
4
5
5
4
4
5
5
5
Nasdaq
Listed1
156.76
165.09
163.04
167.47
192.84
192.79
204.47
207.95
152.01
115.66
196.02
197.60
238.09
Exchange Total
Listed
U.S.
25.44
22.84
26.15
28.35
33.54
29.84
24.35
25.42
20.14
13.11
25.93
31.60
37.00
182.2
187.9
189.2
195.8
226.4
222.6
228.8
233.4
172.2
128.8
222.0
229.2
275.1
Market Share (Island's
ADV as percent of total
market)
(average daily volume)
(%)
Nasdaq Exchange
Listed1 Listed
12.11
12.74
12.75
12.91
13.03
12.76
12.68
12.8
12.99
13.88
12.38
13.62
14.03
1.42
1.41
1.47
1.56
1.65
1.44
1.29
1.24
1.30
1.27
1.36
1.81
1.89
Total
U.S.
5.91
6.44
6.19
6.29
6.45
6.22
6.54
6.35
6.33
6.90
6.36
7.17
7.53
Island – Selected Trading Data
Island's Average Daily
U.S. Equity Shares
Traded (ADV)
(million shares)
Week
Ended
11/29/2002
11/22/2002
11/15/2002
11/8/2002
11/1/2002
10/25/2002
10/18/2002
10/11/2002
10/4/2002
9/27/2002
Average
1
# Trade
Days
4
5
5
5
5
5
5
5
5
5
5
Nasdaq
Listed1
Exchange Total
Listed
U.S.
Market Share (Island's
ADV as percent of total
market
(average daily volume)
(%)
Nasdaq Exchange
Listed1 Listed
223.99
246.54
221.91
254.55
219.33
212.66
203.48
206.03
200.16
190.35
27.93
35.10
31.67
32.55
35.24
35.44
36.51
47.15
41.64
39.62
251.9
281.7
253.6
287.1
254.6
248.1
240.0
253.2
241.8
230.0
13.88
12.89
13.55
13.22
12.88
12.80
12.28
11.77
11.93
12.03
1.59
1.66
1.71
1.59
1.79
1.76
1.75
1.94
1.86
1.90
7.48
6.99
7.27
7.24
6.93
6.75
6.42
6.05
6.17
6.27
196.90
30.72
228
12.87
1.59
6.62
Includes shares executed on a national securities exchange under "unlisted
trading privileges."
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Total
U.S.
Archipelago – Trading Data
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Mo nth
OTC Ord e r Vo lume
02/01/2003
51,594
01/01/2003
62,966
12/01/2002
53,542
11/01/2002
47,639
10/01/2002
52,442
09/01/2002
28,058
08/01/2002
17,431
07/01/2002
20,828
06/01/2002
18,535
05/01/2002
18,488
04/01/2002
13,034
03/01/2002
10,966
02/01/2002
11,741
01/01/2002
10,801
12/01/2001
10,185
Ave ra g e
28,550
OTC Tra d e s
15
20
17
16
18
11
8
10
9
8
8
7
7
7
6
11
N o te : All fig ure s in unit millio ns
OTC S ha re Vo lume OTC D o lla r Vo lume
5,682
104,097
7,722
141,772
6,681
117,047
7,039
120,957
7,889
130,844
4,710
74,318
3,433
52,653
4,121
66,984
3,624
65,774
3,749
72,483
3,485
71,487
2,915
65,490
3,166
71,006
3,221
78,162
2,841
67,322
4,685
86,693
Archipelago – Trading Data
N o te : All fig ure s in unit millio ns
Mo nth Lis te d Ord e r Vo lume Lis te d T ra d e s Lis te d S ha re Vo lume Lis te d D o lla r Vo lume
02/01/2003
62,989
1.18
659
23,266
01/01/2003
64,669
1.17
764
27,025
12/01/2002
52,927
0.88
632
20,915
11/01/2002
63,886
0.89
599
19,798
10/01/2002
65,236
1.39
838
29,044
09/01/2002
28,616
0.78
438
13,846
08/01/2002
20,528
0.93
535
17,578
07/01/2002
20,823
0.95
594
19,370
06/01/2002
16,017
0.77
518
16,091
05/01/2002
19,319
0.72
509
16,827
04/01/2002
15,746
0.61
438
15,950
03/01/2002
11,144
0.52
406
13,704
02/01/2002
12,054
0.51
363
11,311
01/01/2002
15,949
0.46
396
11,605
12/01/2001
13,986
0.35
346
10,229
Ave ra g e
3 2 ,259
0 .81
536
1 7 ,771
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Archipelago – Trading Data
Mo nth
ETF Ord e r Vo lume
02/01/2003
56,147
01/01/2003
58,462
12/01/2002
46,515
11/01/2002
57,505
10/01/2002
58,519
09/01/2002
23,812
08/01/2002
15,089
07/01/2002
16,434
06/01/2002
12,145
05/01/2002
15,291
04/01/2002
12,075
03/01/2002
9,032
02/01/2002
10,242
01/01/2002
13,259
12/01/2001
11,628
Ave ra g e
27,744
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ETF Tra d e s
0.32
0.37
0.30
0.24
0.40
0.19
0.22
0.23
0.19
0.19
0.14
0.11
0.09
0.10
0.06
0 .21
N o te : All fig ure s in unit millio ns
ETF S ha re Vo lume E T F D o lla r Vo lume
293
15,305
344
18,453
284
14,492
238
12,604
389
18,417
158
7,469
177
8,966
209
9,790
157
7,129
169
7,258
123
6,984
92
5,322
77
3,955
79
4,314
65
3,488
190
9,596
ECN’s – The Future
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ECN
Ins tine t
S tre ng ths
High Le ve l o f liquid ity a nd conne c tivity
Ma rke t Le a d e r
We a kne s s e s
Cons id e rs its e lf more tha n jus t a n ECN
Is la nd
Te c hnic a lly s o p his tic a te d a nd a g g re s s ive
Ne e d s to a ttra c t mo re ins titutiona l o rd e r flo w
Archip e la g o Te c hnic a lly s o p his tic a te d
Exc e lle nt s o urc e o f liquid ity from owne rs hip
Ne e d s to a ttra c t mo re o rd e r flo w b e yond its
c o re o wne rs hip a nd pa rtne rs hip s
R e d ib o o k
Conne c tion with S p e a r, Le e d s & Ke llo g a nd
the re c e nt a d d ition of thre e re ta il p o we rho u s e s
T o o much re lia nce o n the ne w o wne rs hip
fo r a d d itiona l liquid ity
Brut
High le ve l o f ins ta lle d us e r-b a s e a nd e xc e lle nt
s o urc e o f liquid ity fro m o wne rs hip
La c k of o p tion fo r curre nt te c hno lo g y
Tra d e b o o k
High le ve l o f ins ta lle d us e r-b a s e , g lo b a l a s p ira tions ,
p a rtne rs hip s with Inve s tme nt Te c hno lo g y Group
La c k of p a rtne rs hip /owne rs hip with dire c t
s o urc e o f liquid ity
S trike
Exc e lle nt s o urc e o f liquid ity from owne rs hip
La te e ntra nt in the m a rke t
Ne xTra d e
24-hour tra d ing , g lo b a l a s p ira tio n s a n d a g g re s s ive
push to b e c o m e a n e xcha nge
La c k of liquid ity a nd conne c tivity, la te e ntra nt
Atta in
Conne c tion to All-te c h, a p o p ula r d a y tra d ing firm
La c k of liquid ity a nd conne c tivity, la te e ntra nt
Source: Meridien Research