From Traders Magazine, June 1998 issue
As STRIKE, the name on the hottest new electronic communications network (ECN) simply suggests, Bear, Stearns & Co. is planning for war – a price war.
STRIKE, the ECN sponsored by Bear Stearns, is going live this summer backed by some of the New York-based firm’s Wall Street peers. And millions of dollars and potential profitability are at stake.
Arthur Pachecho, Bear Stearns’ co-head of Nasdaq trading, and president and chief executive of the firm’s affiliated STRIKE unit, said the new ECN is being marketed as an attractive alternative to Instinet and other ECNs.
STRIKE’s best weapon may be its commission schedule. Pachecho said STRIKE will charge customers “substantially” lower commissions for executions than its competition, but declined to elaborate.
Instinet, owned by London-based Reuters Group PLC, is the largest ECN approved by the Securities and Exchange Commission under terms of the order handling rules, and accounts for an estimated 20 percent of the average daily volume on Nasdaq, or more than 100 million shares.
Instinet’s average commission charges are lower on heavy volume and generally amount to pennies or less on each share per trade executed.
STRIKE, which was approved by the SEC last January, thinks it will soon keep pace with Instinet’s volume, thanks to a potential pool of lucrative order flow, including a network of more than 400 fully-disclosed Bear Stearns correspondent brokers that clear and execute business through the firm.
Bear Stearns’ transaction volume is comparable to Instinet’s, roughly 140,000 equity trades daily and about 12 percent of the business on the New York Stock Exchange.
Moreover, STRIKE is counting on order flow from some of the 15 equity participants and partners in the venture, including Wall Street giants Herzog, Heine, Geduld, Salomon Smith Barney, Donaldson, Lufkin & Jenrette, NationsBanc Montgomery Securities and Cantor Fitzgerald. (Sun Microsystems and NeoVision are also partners.)
“The nature of the owners means we can achieve significant critical mass,” said Pachecho, the soft-spoken 34-year veteran who will vacate his seat on the desk this summer to concentrate fully on STRIKE.
In addition, STRIKE will be available through more than 60,000 Bridge terminals, a move that gives the soon-to-be-launched ECN a widespread reach.
Plans for STRIKE were first hatched in the wake of the order handling rules that made Nasdaq price-quote information more transparent.
Now a customer sending a better price on a stock to a market maker is assured that an order will be publicly exposed or executed by the market maker.
The market maker must either fill the customer’s order, change its own quote to reflect the customer’s superior bid or asked price, or transmit the customer’s order to an ECN.
Bear Stearns’ STRIKE plan was motivated by that ECN display option, and a calculation that it is more cost-effective to use its own ECN rather than a competitor’s, which then collects the agency commission. An average-sized Nasdaq desk may pay Instinet and other ECNs several million dollars annually in commissions.
“There have been significant changes in the regulatory environment. Many changes are beneficial to the investors, of course, but at the same time, market making is much more expensive,” Pacheco said.
“Costs are up and profits are down. One of the costs of doing business is the use of ECNs. The new order handling rules opened up competitive windows and prompted us to compete with the existing ECNs,” he added.
The ultimate effect of having a new gorilla in the ECN business is not exactly clear. Some experts point out that volume on all ECNs has not increased appreciably since the order handling rules, raising the possibility that some ECNs will see a serious erosion in market share.
What’s more, the National Association of Securities Dealers’ proposed integrated order-delivery and execution system has raised more fears that business on ECNs will be crimped if the system is implemented.
Nevertheless, the ECN industry has some feisty competitors. Other ECNs launched after the rules took effect include Bloomberg’s Tradebook and Automated Securities Clearance Corp.’s BRUT. Last October, the SEC and NASD approved an ECN that is operated by New York-based Spear, Leeds & Kellogg.
Among the newest upstarts, BRUT, or Brass Utility, has also engaged in a price war – of sorts. The system, which was recently approved by regulators, essentially “rewards” traders for using the ECN.
On a trader-to-trader transaction, for example, the trader entering the order into BRUT will be paid $1, while the broker taking liquidity from the system would be charged $4.
Thus, a 5,000-share transaction would cost a mere $3, compared to ten times the cost of doing the same transaction on alternative ECNs, according to a BRUT official.
BRUT is pitched as a customer service by Weehawken, N.J.-based Automated Securities Clearance, or as an accessory to order-management and routing software the company sells to market makers (that product handles a large proportion of Nasdaq business). But for Bear Stearns, ECNs are a means of remaining in business.
Bear Stearns, however, has an obvious advantage over other ECNs that do not have the luxury of a ready-made critical mass of order flow. “New ECNs really faces an uphill battle,” one expert said. “Traders tend to think that time can be lost waiting for an execution if they send their orders to a smaller ECN.”
The development costs for STRIKE, estimated by industry sources at $15 million to $20 million, were paid by Bear Stearns, Pachecho said.
“Even though Bear Stearns has borne the costs, STRIKE is not exclusively owned by the firm,” Pacheco stressed.
STRIKE software is written in Java programming language, developed by Sun Microsystems. All applications or software written in Java can be deployed on any platform.
In other words, STRIKE will work equally on a PC, Macintosh or a UNIX computer. The only requirement is a Java-powered browser, such as the latest version of Netscape Navigator or Internet Explorer, both of which are available free from their respective web sites.
Traders can access STRIKE through their order-entry screens on Bridge terminals. Additionally, a fixed API (a type of application) enables companies to integrate the ECN into their trade-order blotter and backoffice software. Like other compliant ECNs under the order handling rules, STRIKE will be linked to Nasdaq via SelectNet.
Users will be able to access the system initially through a secure proprietary network developed by Bear Stearns, or through networks provided by Bridge, according to Bear Stearns marketing material.
Pachecho is confident. ” In most cases traders do not have to invest in new software or hardware, or in expensive real estate, to access STRIKE,” Pachecho said. “STRIKE is ready to roll.”