Catching up with Advanced Trading

By: Ray Pellecchia

File Under: NYSE

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Some interesting stuff re: Hybrid and other issues in the current Advanced Trading magazine.

The cover story is "Crossing the Line? Brokers are opening up their internal crossing networks to the buy side, even going so far as to register them as ATSs. But buy-side firms, such as Pioneer Inveswtments, say they aren't interested if proprietary trading desks are involved." To read the buy side's concerns, you have to get to page 4, but it's worth checking out:

While the incentives for the sell side to push crossing networks are clear, and while buy-side traders agree that internal crossing networks can benefit them by lowering market impact, the buy side is raising questions about whether sell-side crossing systems are anonymous and whether the proprietary trading desks at these firms have access to the networks. "We would have to have some guarantee that there'd be anonymity," says Pioneer Investments' Gauvain. "That's the paramount concern if you're going to use any crossing network." Gauvain stresses that he would want to know who has access to his trading information.

In particular, buy-side clients want to know if there is any potential for information leakage with proprietary desks. "If the proprietary desk is getting hits in a crossing network, they can use that as information," explains Gauvain.

"If I knew that their proprietary desk could participate, it would not be of any interest to me to use a product like that," adds John Myles, vice president and senior domestic trader at Pioneer.

When firms that operate internal crossing networks also do proprietary trading, "It's a huge concern," confirms OPERS' Stack. "When we sign up for direct access with a broker, one of our first requirements is that flow does not cross a proprietary desk," she says. In fact, many brokers are offering an audited statement that shows that the flow from the buy side through DMA does not pay a visit to the proprietary desk, Stack notes.

Also:

In addition, Joe Gawronski, COO of Rosenblatt Securities, an institutional agency broker, is concerned that brokers that do proprietary trading can aggregate all the data from the crosses to glean information about trading patterns that can then be used to customers' disadvantage. "If they say we don't look at your orders, that fact is likely true on an individual order basis," he says.

However, Gawronski suggests that the next question that needs to be asked is whether they do in fact look at information on an aggregate basis. For instance, "If they see there are 3 million shares to buy and 100 million shares for sale in their system, how do they deal with that?" Gawronski asks. "The big brokers are not making their profits on the agency trading - they're making it on the proprietary trading, so tough questions are warranted," he says.

Other questions are emerging regarding fragmentation caused by the emergence of multiple crossing networks. "I don't think the trend is all that favorable for the buy side," says OPERS' Stack. "It fragments liquidity," she explains. "Six or seven years ago, we had 14 ECNs - they all consolidated down to a handful. Now, this is refragmenting the liquidity again."

Closer to home for this space is another article, "Ready or Not," about preparations here and elsewhere in advance of Reg. NMS:

For their parts, the exchanges seem to be on track to meet the deadline. Spokespeople at the New York Stock Exchange (NYSE) say that 140 stocks now have been brought onto the Phase I pilot of its Hybrid Market trading system, which complies with Reg NMS rules. Phase I is scheduled to be completed March 13, with Phase II rolling out three to four weeks afterward.

Of course, that's a bit dated because the magazine is bi-monthly. But the point that we're on track is accurate, and we'll keep you updated as we get further into Phase II.

One other article to mention: "Compliance Question? Ask NYSE":

NYSE Regulation unveiled Ask Market Surveillance, a software-based legal research tool intended to help floor members and their legal and compliance officers answer questions about NYSE trading rules.