Trading Stock around the Clock: The Future Growth of Global Electronic Markets

Brothers Salomon , “International Equity Flows,” August 1989, p. 2.

Brothers Salomon , “International Equity Flows,” July 6, 1990.

Ibid., p. 2.

Some months after the inauguration of after-hour electronic trading, traders on the Big Board were disappointed with the meager results. Volume has been negligible as big institutions continue to send their after-hour trades to unregulated markets with less disclosure and lower costs.

Competition to the NYSE has become particularly intense in recent years not only in terms of institutional trades, but retail trades as well. Recent reports indicate that the Midwest Stock Exchange has been successful in bidding for small orders by rebating one or two cents commission per share to brokers. Market makers on the Midwest Exchange appear willing to pay this fee out of their market maker spread in tough new competition with NYSE specialists. The Intermarket Trading System, discussed below, permits Midwest specialists to reduce their risks by enabling them to dispose of stocks, or to acquire them, on this electronic system linking all U.S. exchanges. The purpose of establishing the system was, of course, to provide precisely this kind of market-maker competition.

“Trading Around the Clock,” Background Paper, Office of Technology Assessment, U.S. Congress, July 1990, p. 16.

Pre-opening matches of equities on the NYSE, though executed through the “SuperDot” system, still involve participation by Exchange specialists.

“Thus, the interaction of buyers and sellers determines the price of an NYSE-listed stock. In contrast, in the over-the-counter market, the price is determined by a dealer who comes between buyer and seller on every trade.” [Annual Report, NYSE, 1989, p. 19.] Though the technology of an electronic auction market exists, it is doubtful that a single specialist system with unique market obligations can persist.

By January 1992, NASDAQ plans to extend its operating hours in London to 3:30 A.M.–9 A.M. New York time. For a discussion of this plan, see the final section of this article.

Large orders are often termed block trades, which the NYSE defines as trades of 10,000 shares or more.

“The Wild, Wired World of Electronic Exchanges,” Institutional Investor Magazine (September 1989), p. 93.

Redwood John Mr. , U.K. Corporate Affairs Minister, recently recommended a new stock market for smaller investors and for trading smaller companies. The Financial Times, August 14, 1990.

Institutional Investor Magazine (July 1990), p. 190. London's international volume exceeds its trading in U.K. stocks. Nearly two-thirds of its international volume was in European blue chips, and half of that was in German equities.

Instinet, an order matching system, executes about 13 million shares a day in NYSE and OTC stocks, as well as U.K., French and German securities.

Opposition has come from traders called “locals” since Globex leaves little room for them. In general, to the extent that an electronic system improves the dissemination of information and the efficiency of markets, floor traders will see their profit opportunities diminish. NYSE Chairman John Phelan once commented: “Technology and communication bring efficiency. Money is made in inefficiency.” [Institutional Investor Magazine (September 1989), p. 92.]

That rule was approved by the SEC to avoid fragmenting orders among competing trading systems. If buy-sell orders are split among a number of execution systems, there will be no opportunity to offset orders against each other and achieve “best” price or narrowest bid-offer spreads.

The NYSE discovered the power of this Catch 22 phenomenon when it embarked too late on its own options and futures trading and found out how difficult it is to divert orders from the dominant, most liquid market. Like the NYSE, Globex will commence trading in off-hours only. Neither market will follow the strategy of the London Exchange, which chose to dive into uncharted waters and adopt a fully-blown new trading system during the regular trading day.

In a recent instance involving the trading of a basket of stocks, the NYSE jettisoned its single specialist system in favor of competing market makers.

The point could be made that, in reality, wholesale and retail orders are basically different and should be handled separately. The SEC reached this conclusion recently with respect to private placements of bonds and stocks, allowing them to be traded without public exposure under Rule 144a.

Responding to pressure from foreign firms and governments, Tokyo now has 22 foreign members, each paying close to $10 million for a “seat.” Effective economic access is also restricted by the continuation of a fixed level of minimum brokerage commissions.

Except for Tokyo, where commission rates remain fixed.

“Trading Around the Clock,” op. cit., p. 33.

At present, the NASD is awaiting SEC approval of an electronic screen-based trading system that would trade between 3:30 A.M. and 9 A.M. Eastern time and would include Big Board issues.

It is useful to distinguish between 1) the off-hour trading of domestic stocks by foreigners, say a U.S. stock by Japanese investors, and 2) the trading of foreign stocks by foreign investors. In the first instance, Japanese investors may wish to trade U.S. stocks during the Japanese trading day, although at present they seem willing to await the regular NY opening. In the case of Japanese stocks on the NYSE, say the Sony Corp., Japanese investors will want to trade off-hours only if the NY market during these hours is better than the domestic market in Tokyo. The availability of extended trading hours may itself encourage off-hours trading in both circumstances.

Cf. Freund William C. , “Can Computers Keep Traders Honest?” in The Wall Street Journal, August 11, 1989.

For a good discussion of the issues in regulating global securities trading, see “Trading Around the Clock,” op. cit., chapter 6.

Financial Times, September 11, 1989.

The conceptual basis for such an approach was submitted to the National Market Advisory Board as early as April 1976 in a document, “The National Book System,” by Mendelson Morris Peake Junius Williams R.T. Jr.

The New York Times, December 26, 1989.

London's International Exchange, however, recently decided to relieve institutional traders, who often seek to hide their full intentions during the trading process, from the immediate reporting of large trades. New rules relieve dealers from reporting until the next day (and maybe not even then) all trades of more than £100,000.

Financial Times, April 19, 1990.

“Trading Around the Clock,” op. cit., p. 3. This report contains an excellent discussion of all phases of international clearing and settlement.

Financial Times, September 11, 1989. Trades are cleared within a prescribed five day period in the U.S. In London there are two 2-week transaction periods each month, with settlement made six business days after the end of each trading period. In Italy the process can take five weeks, in France six weeks.

Word has it that Luxemburg is considering building a central settlement system for European shares via Cedel. The Economist, March 10, 1990, p. 82.

One example is London's recent trouble in maintaining trading in its less active stocks. The absence of specialists and auction market procedures may be responsible. Spreads in these stocks have widened from an average of 3 percent in 1987 to more than 10 percent in 1990. Consequently, the London Exchange is now investigating the possibility of introducing specialists in trading its less active stocks.

Private letter from Mr. J. Pearce Bunting, President and Chief Executive Officer of the Toronto Stock Exchange. Particular thanks are due Mr. Bunting for sharing his experience and insights.

It may be desirable to provide instant currency conversions so that international participants can trade in their own currency. The Amsterdam Stock Exchange now trades foreign stocks in their home currencies. With currency hedging readily available, investors can protect themselves against adverse currency shifts, though that is more cumbersome and adds to costs.

Reuters, which now operates Instinet, an order-matching system for stocks, probably has the best shot at developing such a comprehensive trading network among all the private vendors of informationa and stock trading systems.

If, contrary to expectations, a proliferation of electronic markets develops with no geographic dominance by any one, some way will have to be found to link markets to avoid order fragmentation and executions at inferior prices. Though arbitrage is the traditional vehicle for reducing price gaps among markets, it is not cost-free and is unlikely to work as well as full price competition among all orders.

The Wall Street Journal, October 25, 1990.