From Trader’s Magazine, October 1998 issue
Nasdaq will learn next year just how well an Internet-based market-making trading system performs.
Several Nasdaq trading desks are among the guinea pigs for a pilot program aimed at testing the reliability and security of the Internet-based successor to Nasdaq’s Level II workstation. And the results of the pilot will be watched with anticipation, if not bated breath.
“The Internet is going to be the highway of the markets of the future,” said Gregor Bailar, chief information officer of the National Association of Securities Dealers, Nasdaq’s parent.
“We see it as an enabler and a catalyst, which helps create a more liquid and a more efficient market,” he added.
Nasdaq declined to identify the participants in the pilot, though it said market makers and others will be involved. “It is limited to a small group,” a spokesman for Nasdaq said. “Our goal is to implement the pilot by the middle or the end of next year.”
If the results of the pilot are encouraging, Nasdaq may never be the same again.
The machinery for market making on the world’s largest intranet (or extranet, as others describe it) would no longer include an expensive proprietary network. Rather, it would be replaced by the World Wide Web and 6,000 PCs, instead of 6,000 trading terminals.
Today’s proprietary network is vast, encompassing Unisys 4800 mainframe-based computers for stock quotes, and clusters of Tandem Himalaya K20,000 computers running Nasdaq’s transactional systems, including SOES and SelectNet.
Most importantly, market makers would welcome the Internet’s potential to drive transaction costs down on each trade executed on Nasdaq.
Driving down costs, in fact, may be the most important goal for Nasdaq as the new millenium nears.
Undoubtedly, it could make Nasdaq the most efficient and lowest-cost equity market in the world, at least until competitors catch up, analysts suggest.
Transaction costs could be reduced by an estimated 50 percent. Not surprisingly, doing so is a favorite theme of Nasdaq President Alfred Berkeley.
“We strongly believe that the future belongs to the market that is the low-cost provider,” trumpeted Berkeley in a speech before professionals last year at an equity-trading conference sponsored by New York’s Baruch College.
“In other words,” he added, “markets will follow costs. They have in every other market, and they will in ours.”
Berkeley’s ascension to the top post at Nasdaq in June 1996 was no surprise, given his background as an analyst in electronic commerce and software development when he was a managing director at Baltimore-based Alex. Brown & Sons, the predecessor firm of BT Alex. Brown & Sons.
While some analysts doubt that Nasdaq will move market making onto the Internet anytime soon, the electronic dealer market has nonetheless shown what can be done in other areas.
In 1998, Nasdaq will spend more than $14 million developing its current sites, twice as much as it did in 1997. (Overall, Nasdaq has earmarked $600 million over five years for the expansion of its network.)
Berkeley is adamant that Nasdaq must move the entire marketplace onto the Internet to remain a viable entity. His view is that Nasdaq’s technology curve has peaked. No matter how much more is invested, performance will not improve appreciably.
“The technology curve that Nasdaq is part of derives from the 1960s, when Dartmouth University came up with computer time-sharing, which allows multiple users onto the same computer,” Berkeley explained in his New York speech.
“Guess what?” he added. “We have pushed the existing technology curve as far as it will go, and a new technology curve is on the horizon. It is as threatening to Nasdaq’s trading technology as our technology was to its predecessor.”
Nasdaq has outlined three steps that will bring it completely onto the Internet.
The first step is already taking place putting quotes on the Internet on a 15-minute delayed basis. Nasdaq’s site, www.nasdaq.com, is attracting more than 20 million hits daily, most of them for stock quotes.
In addition to a site for investors in the U.K. at www.nasdaqonline.com, Nasdaq has a site customized for traders, www.nasdaqtrader.com, which features technical and regulatory information.
Early next year, Nasdaq will launch a subscription-based enhanced service on www.nasdaqtrader.com. The premium service is being tested by Nasdaq.
The second step involves order-entry functions on the Internet. There are more than 70 companies now gathering stock orders on the web, and that is expected to grow exponentially over the next two years.
Nasdaq is using the Internet to implement its Order Audit Trail System, or OATS, for collecting trade data. Market makers will send that data via secure e-mail, or through the FTP protocol.
“Our efforts to automate OATS on the Internet will only lower the costs of implementation,” Bailar said. “After all, the only other option is paper.”
Last month, Nasdaq replaced its DOS-based Mutual Fund Quotation System with a browser-based, secure web site, to make it easier for fund managers to submit price information by their daily deadlines. Fund managers have just under two hours from the market’s close to calculate their mutual-fund prices and transmit them to Nasdaq.
Previously, fund managers had to manually enter prices for each of the funds. Using the Internet, fund managers can import ASCII files with the prices for several funds. The new system is flexible and speeds up the submission process.
“It gives users the ability to efficiently update and view information on the Internet,” Bailar said.
Nasdaq is viewing this mutual-fund service as a preliminary pilot program before it engages in a full-fledged test of a live trading environment next year, which is the third step in Nasdaq’s plans actual market making on the Internet.
Much of the infrastructure that will facilitate Nasdaq’s move onto the Internet is already in place, of course. Nasdaq trading terminals are connected by a quarter-of-a-million miles of leased network capability run by industry giant MCI Worldcom. The network links data vendors to more than 420,000 information boxes around the world.
The Nasdaq computer hub is in a nondescript 10,000-square-foot facility in Trumbull, Conn. A backup site is housed in Rockville, Md.
But security and reliability, as well as speed of delivery, are major obstacles to be finetuned if Nasdaq is to more fully embrace the Internet.
Reliability, acknowledged Bailar, “will make it a means for efficient communications between the firms and us.”
“Nasdaq has a great web site, providing proprietary access to members’ content,” added Dan Connell, president of Harrison, N.Y.-based ComStock, a provider of Internet-based market data for Nasdaq traders and other professionals. “You hit enter, and you get a response back pretty darn quickly from Nasdaq.”
But Connell does not think Nasdaq will switch market making onto the Internet anytime soon. “For a start, keeping it on a real-time environment is not that easy,” he said.
But even ComStock and other vendors overcame the reliability and time-sensitivity factors with their own market-data products. Though they are not perfect solutions, they are cheaper than more conventional data-service products. (ComStock on the Internet handled 50,000 trades in August, representing more than 40 million shares.)
The Internet is a pervasive tool of online trading firms, such as the San Francisco-based discounter Charles Schwab & Co. and New York’s Datek Online. Roughly 20 percent of stocks are now traded on the Internet, much of that via online brokers.
To be sure, some online discounters have crashed during periods of heavy market volume. But these firms are confident such troubling occurrences will be rare in the future.
Putting Nasdaq Level II workstation on the Internet is attainable by the end of 1999, thinks Kenneth Pasternak, chief executive of leading Nasdaq wholesaler Knight Securities. But to have a full-fledged trading system, it would then be necessary to integrate order-management systems and data-service bureaus via the Internet, he added.
Moving to the Internet, however, does make some market makers squirm. After all, capital and proprietary positions are at stake. Nevermind that Nasdaq’s proprietary network is a hard act to follow. Data is transmitted to end users within a nanosecond actually within a 300-millisecond simultaneity throughout the U.S., or practically real time.
Greg Cline, a principal analyst of Internet-architecture research at Newton, Mass.-based Cahners In-Stat Group, said the best solution for Nasdaq would be a guarantee-service contract with a private Internet Protocol, or IP network provider.
“That way, data would be transmitted across a dedicated network instead of over several networks, which causes potential delays and an uneven distribution of data,” he said.
The “public” Internet cannot be relied upon yet to distribute data among trading professionals with a guarantee that each will receive the same information almost simultaneously. But Nasdaq is undaunted. “We know that we have to move to the World Wide Web,” Berkeley told his New York audience.