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Thursday, 4 April, 2002, 19:37 GMT 20:37 UK
Investor woes threaten electronic markets
Nasdaq Market Site, Times Square, New York
ECNs are vying for their share of Nasdaq stock trades
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David Schepp
BBC News Online North America business reporter
line

A little less than a year ago, the New York offices of news agency Reuters were all astir over the forthcoming float of shares in the firm's electronic trading network, Instinet.

Some employees took advantage of a scheme set up by the London-based firm that allowed them to purchase shares at the initial-offering price of $14.50 (10).

In the days and weeks that followed, Reuters workers cheered as the stock rose to near $22 a share.

By mid-summer, however, Instinet shares had begun a swift decline, falling below their $14.50 offering price after just 10 weeks of trading.

Now, with Instinet shares trading below $7 in recent weeks, Reuters is considering buying the remaining 17% of shares it does not own or merging Instinet with a rival.

In doing so, Reuters hopes to salvage its investment in an industry rocked by stiff competition, falling stock prices and malaise among investors.

Falling volume

Instinet was launched in 1969, the first of what were termed by the Securities and Exchange Commission (SEC) as electronic communications networks (ECNs).

ECN Benefits
Better prices
Slick execution
Modern technology
Anonymity for customers
More than half-a-dozen have sprouted in recent years, crowding an already competitive field, resulting in a number of mergers.

One recent example is Chicago-based Archipelago, launched in 1997, and broker-dealer owned RediBook, which completed their merger in late March.

But strengthened firms will find little comfort in competing for slim profits in an investor-weary market.

Skittish investors litter the investment landscape, still spooked by the once-ailing US economy and last September's suicide attacks.

Decimalisation

Fewer trades resulted in a 24% reduction in Instinet's share volume in February, compared with year-ago figures.

Traders on the floor of the New York Stock Exchange (NYSE)
ECNs trade shares without the use of floor traders
That significant fall may lead Instinet to announce its first-ever loss when it reports its results for the first three months of 2002 on 18 April, the firm warned last month.

Nevertheless, analyst estimates still call for Instinet to realise a profit of 11 cents a share, according to a poll conducted by Zacks Investment Research.

Instinet's ails, however, are hardly unique.

On Thursday, Knight Trading, a competing electronic trader, said it also expects to announce a first-quarter loss, attributable to reduced trading volume as well as its aggressive overseas expansion.

Also adding to the pain being endured by ECNs is the recent switch by US markets to trading stocks in pennies rather than fractions, or decimalisation.

That has reduced the so-called "spread" - the difference in price between the seller's asking price and what the buyer is willing to pay - and has further eroded profits.

Volume leader

Recent reports have suggested Reuters is looking to merge Instinet with a rival in order to maintain its top spot as the leading electronic trading network, handling more than half the shares traded across all ECNs.

Nevertheless, Instinet, short for Institutional Network, has seen its share of Nasdaq-traded stocks threatened by rival Island ECN.

Island reported on Tuesday that it handles a quarter of all trade volume on the Nasdaq Stock Market, a number that puts it ahead of Instinet.

Those figures, however, are questionable, according to Nasdaq officials, whose statistics show Instinet as the volume leader.

Instinet's electronic network is the oldest of its type. It operates in 40 securities markets throughout the world, including stock exchanges in Frankfurt, London, Paris and Tokyo.

Matching buyer and seller

All ECNs benefit from several advantages of trading shares of stock electronically, including lower prices and anonymity for customers.

The electronic networks use modern technology to improve the efficiency of trade execution, which often gives them an advantage over older, more established exchanges, such as the New York Stock Exchange (NYSE).

Because ECNs eliminate human interaction in the share-trading process, the system allows investors to trade anonymously, matching buyers and sellers in a sort of stock traders' dating service.

The downfall to ECNs is that unless there is an exact match, the sale cannot be executed.

It is analogous to Instinet's current share-price woes. At roughly $7 a share, Instinet might seem a bargain but few suitors may emerge.

Analysts say with investors - including Reuters own employees - now holding shares worth less than half what they paid for them, finding a merger-willing peer to face angry shareholders could be a challenge.

Reuters itself, in proposing its own buyout deal, may find itself reticent in an era defined by jaded investors - some of who also happen to be employees.

See also:

02 Apr 02 | Business
Profit woes invade Wall Street
04 Mar 02 | Business
Nasdaq chief: Reforms not needed
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