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Friday, 12 January, 2001, 09:22 GMT
Fight-back threatens electronic exchanges
Wall street traders
ECNs aim to be more efficient than exchanges
The future of stock exchanges has been under threat as new electronic share-trading networks have flourished. But now existing exchanges are planning a fight-back against their electronic rivals, as Emma Clark explains.

The ECN, or electronic communications network, is one of those bland terms that mean little to the uninitiated.

Even the experts quibble over a definition, mainly because ECNs are a multi-faceted breed.

In the crudest terms, an ECN is an electronic market for buying and selling shares.

It links up brokers and market-makers that trade on behalf of institutional or retail investors.

Sometimes, it also gives investors direct access to the market.

ECN Benefits
Better prices
Slick execution
Modern technology
Anonymity for customers
The general idea is to cut out the middleman - often exchanges that were used traditionally to trade stocks - and to provide the best prices for ECN customers.

Some ECNs only match orders for stock within their own systems.

Others, such as the US-based ECN Archipelago, will also go to other markets or exchanges to find the best price for their customers.

The pros and cons

The attractions of ECNs include lower prices and anonymity for their customers, as well as slick execution of trades.

They use modern technology to improve the efficiency of trade execution, which often gives them an advantage over older, more established exchanges.

It is not a 100 metre dash, it's a marathon

Lynton Jones
chairman, Jiway

But the chief problem ECNs can face is achieving enough liquidity, or a high enough volume of trades conducted through network, according to Marc Rubinstein, research analyst in electronic brokerage at Credit Suisse First Boston.

Without decent liquidity, it can be difficult to keep prices down. And if the prices aren't good, the ECN could be fighting for its survival.

Born in the USA

ECNs first emerged in the US.

In January 1997, the US Securities and Exchange Commission (SEC) implemented new Order Handling Rules which compelled stock markets, especially Nasdaq, to display the best prices for their stocks.

Previously, it had not been necessary for members of Nasdaq to advertise their best bids and offers.

ECNs often began as competitive price-display systems, which then developed into their own mini markets.


The major ECNs in the US include Archipelago, Instinet, Island, BRUT and Redibook.

According to, Instinet and Island trafficked 57.3% of the orders routed through ECNs in the second quarter of 2000.

Overall, ECNs account for about 30% of Nasdaq share volume.

However, Nasdaq has become determined to claw back business. It recently received approval from the SEC to launch a new system, called SuperMontage.

At its inception, SuperMontage aroused great hostility from the ECNs because they saw it as an anti-competitive attempt by Nasdaq to reclaim market share.

Prior to SEC approval, SuperMontage underwent eight revisions in order to appease the ECNs.

European ECNs

In Europe, there is less opportunity for ECNs to replicate the US model. This is because many of the European exchanges are order-driven, meaning prices tend to be more competitive.

In the past, the New York and London stock markets had "jobbers" who posted their own prices for stocks, serving as intermediaries for direct customer orders.
European ECNs
Bloomberg Tradebook

This has pushed ECNs entering the European market to develop in a different way, said CSFB's Rubinstein.

Some are tailoring their service to the retail investor, instead of the institutional investor.

This does not mean that they necessarily allow retail investors to trade directly over their networks. Usually it means that the ECNs target the online brokers that serve retail investors.

Troubles ahead?

Some analysts believe that this leaves ECNs vulnerable to the recent downturn in the stock markets.

Retail investors, in particular, tend to batten down the hatches during such market upheaval, said CSFB's Rubinstein.

One such example is Jiway, an alternative trading system that launched a pan-European electronic market last November.

Most of its customers are online brokers. One of them, Sweden's Avanza, is now scaling back its ambitious expansion plans in Europe.

Man by computer
Some European ECNs target the retail investor

Lynton Jones, chairman of Jiway, however, remains upbeat about the downturn.

"It may mean growing more slowly than would have been the case with the Nasdaq boom. But it is not a 100 metre dash, it's a marathon. We are in it for the long-term growth."

New Entrants

But just as the original ECNs cannibalised Nasdaq, online brokers are also looking to get in on the act.

Even the traditional exchanges are acting as unlikely bed fellows.

For example, the German online broker, Consors, plans to participate in the Berlin Stock Exchange's project to launch a retail ECN.

A Consors spokeswoman said the project would lower the commission charged on trades for retail investors.

The Berlin Stock Exchange hopes to launch the ECN this year.

Existing ECNs in Europe include Instinet, Tradepoint and Bloomberg's Tradebook.

The rush to participate in new ventures both in Europe and the US bears testimony to the success of the ECN model.

However, the ECN's knack of adapting to market quirks will certainly be tested as bearish markets and new competitors threaten to put the squeeze on its liquidity.

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See also:

30 Jul 99 | The Economy
Nasdaq to go public
11 Jun 99 | The Company File
Wall Street giants challenge exchanges
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