Brokerage firms that once made their living solely on the floor of the New York Stock Exchange-downstairs-are few and far between these days. The surviving firms that have outlasted the industry’s move to electronic trading did so by reinventing themselves. Some moved a good portion of their operations off the floor-to upstairs desks. Others have tried to broaden their trading niche more gradually as they expanded into new services for customers.
“To really succeed in the current trading environment, trading firms that were floor brokers must transcend the New York Stock Exchange,” says Craig Rothfeld, executive director at institutional broker WJB Capital Group. “Their business strategy shouldn’t be guided by decisions made by the NYSE management about the New York market.”
Floor brokers, who once dominated trading at the NYSE, have had their heads handed to them over the last couple of years. In June, they represented 6 percent of the NYSE’s volume, down from almost 18 percent in in the first quarter of 2007. Competition from electronic trading tools and regulatory change–a.k.a. Regulation NMS–have decimated the once-thriving NYSE floor.
But what shrank the floor community may have made the remaining brokerages with floor operations more resilient. That, at least, is the argument some expound on the floor. These firms have passed through a long hard winter of consolidation, and many are emerging with leaner operations and a dual upstairs-downstairs focus that could lead to more-versatile futures. At the same time, the NYSE is finally trying to spruce up the ability of floor brokers to execute orders on the floor, where, for the last year, many say they’ve been disadvantaged compared to upstairs desks.
“As a floor broker, you’re nowadays in the same situation as you would be as an upstairs trader,” says Samuel Lek, CEO of Lek Securities, a direct-access agency execution firm that clears for professional clients across equities, equity derivatives, futures and fixed income. “Floor brokers have become plain-old sales traders and they have a duty to route to the best market, not just the NYSE.” Lek Securities, which has two floor brokers, now sees its NYSE operation as a “plain-vanilla part of the company’s business.”
To enable floor brokerages to compete more easily with upstairs desks, the NYSE last year relaxed its grip on them. In June 2007, the exchange lifted a rule that prohibited floor brokerages from trading NYSE-listed products in other market centers. Brokers and clerks, now called sales traders, can reach all trading venues and trade all NMS securities from their booths, once they get the necessary regulatory approvals. As a result, some floor brokers are now accessing dark pools, trading Nasdaq and American Stock Exchange-listed products, and sending pieces of orders algorithmically into the market as they work big orders for customers.
Point of Sale
Daniel Tandy, senior managing director at institutional broker Prime Executions and an executive floor governor at the NYSE, admits that floor brokers used to reside at the top of the totem pole. “The exchange was where the liquidity was, and we had a point-of-sale advantage,” he says. “Clearly, that’s why customers used us.” But the NYSE’s Hybrid model, he says, destroyed that old model, without giving floor brokers the tools to represent orders as agents effectively in an electronic environment. Scores of brokerages couldn’t persevere, and closed shop or merged with other firms to consolidate their business.
Competing with upstairs trading desks can now be a tall order. “As we set ourselves up as broker-dealers to compete with upstairs firms, obviously we must have the same access and abilities as those firms,” Tandy says. “But for me to be on an even keel with the Goldman Sachs trading desk-well, it’s very, very difficult for small firms to operate in that type of environment.”
What happened to floor brokers is simple. Their alma mater changed as the regulatory environment got overhauled, and the NYSE had to appeal to a wider range of constituencies. The NYSE remains the CNBC-courting star of the trading world, but it is now just one of the markets that make up the NYSE Euronext exchange operator. Cash trading at the NYSE and NYSE Arca together provided 13 percent of NYSE Euronext’s revenues in the first quarter of this year, compared to 20 percent from European cash trading and 25 percent from derivatives trading.
At the same time, Regulation NMS transformed the market for Big Board securities, making it electronic, and then fragmented. The NYSE’s market share in its own names in June was 30.5 percent, down from 80.2 percent in June 2005, when the Securities and Exchange Commission adopted Reg NMS. That June was the last month the exchange’s market share exceeded 80 percent.
And as the NYSE changed, so did floor brokers. In response to the New York’s declining market share and the changing marketplace, floor brokers were forced to trade in other markets. They could no longer simply work an order on the NYSE because the NYSE no longer controlled the bulk of the liquidity. And now, in an increasingly fragmented environment, they can’t just work the piece of the order targeted for the Big Board. They must compete with their bigger upstairs cousins for the entire order, and that means competing in markets and with tools they didn’t need to access even a couple of years ago.
Moving On Up
The biggest institutional brokers and former NYSE floor brokerages have tried to re-aggregate splintered listed volume upstairs. Some have strengthened their execution businesses by trading in other venues from their booths on the floor, but many by moving off-floor or expanding their existing upstairs agency desks. Some have traded Nasdaq stocks for years, but the operations were run as distinct businesses. Those distinctions are now less and less relevant. Many firms have added international trading, research, execution consulting or other services.
Donato J. Cuttone, vice chairman of institutional broker Cuttone & Co. says his firm conducts its business across all marketplaces, dark pools and ECNs, with an upstairs trading desk and a floor coupled together. “We’ve diversified our tools, products and customers,” he says. Half a dozen years ago, Cuttone was the largest independent floor operation at the NYSE, with 10 floor brokers and 22 clerks. The firm still has a huge footprint on the floor-seven brokers and 16 sales traders-but it’s now focusing on its upstairs business. Cuttone says the company is more than doubling its current off-floor desk of 10 sales traders.
Meridian Equity Partners, JNK Securities, Rosenblatt Securities and others with big presences on the floor are also growing upstairs. Rosenblatt currently has nine brokers on the floor, but plans to expand its upstairs desk to 18 sales traders from its current 10 over the next few months, according to Richard Rosenblatt, the firm’s founder.
Some firms on the Big Board floor have continued to make a living by focusing on what they’ve always done as they expand their product turf and customers. David Shields, president of Shields & Co., an institutional broker and direct-access NYSE member firm, points out that consolidation on the floor has helped some floor brokers remain viable. “The people on the floor doing a beeper business has certainly shrunk,” he says, referring to order flow that comes from other member firms on the floor. But some firms that eliminated their floor presence “still want to have representation, so they’ll use $2 brokers such as ourselves.”
More broadly, the bigger shift that the NYSE and floor brokerages are dealing with these days is the gradual decoupling of their respective needs and interests. For most floor brokerages, the NYSE now represents just a single liquidity pool they must access, although it remains the largest. For the New York, floor brokers are a single constituency, albeit one whose history is intimately tied to its own.
Jonathan Corpina, senior managing partner at Meridian, points out that his firm’s floor operation is “just one piece of our equity trading.” The firm, which trades 80 percent listed securities, has roughly half of its 33 personnel on the floor and the other half upstairs. Brian Pfeffer, chief operating officer of Direct Access Partners, an NYSE/FINRA broker-dealer that was among the first firms approved to route out to other markets from its NYSE booth, also sees the floor differently these days. “We now think of the floor as another [office] branch for our firm, another way to access liquidity,” he says.
Still, while floor brokers must trade in the listed environment that currently exists, most floor brokerages would like the floor to again become a robust liquidity pool they can use to service clients’ block needs. Floor brokers’ two main calling cards continue to be execution parity and the ability to discover price on large orders. Parity with the exchange’s display book gives those on the floor a benefit that upstairs traders don’t have. Parity is a “definite advantage, particularly for less-liquid stocks,” Cuttone observes. “We continue to use floor brokers to represent orders when that’s important.”
Price discovery for blocks has always been a forte and point of differentiation for the exchange as well as floor brokers. “The ability to negotiate large trades is something humans still do better than machines,” says Meridian’s Corpina, who is also president of the 350-person Organization of Independent Floor brokers. “We’re able to have conversations with other brokers to find liquidity and depth in the market. When you’re upstairs and relying solely on computers, it’s harder to find that liquidity.”
Pfeffer of Direct Access Partners adds that price discovery remains important to the buyside, especially for blocks and around the open and the close. “It’s easier to trade electronically during the day because the stock finds a level, but in the first hour and last hour stocks tend to be more volatile, so the buyside needs more help in determining the price at which they should be buying or selling,” he says. WJB’s Rothfeld mostly agrees, adding that in the current fragmented market, “conversation is trying to make a comeback. Anything that promotes talking and price discovery will be good for business.”
Hybrid Problems
However, the NYSE hasn’t focused on the execution needs of brokers in recent years. Rosenblatt Securities’ founder points out that the NYSE didn’t treat floor brokers well in the Hybrid rollout. “When Hybrid was implemented, the theory was wonderful,” he says. “The idea was to enhance what brokers provided clients with electronic capabilities. But its implementation wasn’t handled well. The ability to represent orders verbally was eliminated, while electronic replacements were inadequate and unreliable.”
Ben Willis, senior floor trader at agency brokerage firm R&H, one of the early direct-access firms at the exchange, goes a step further. “Floor brokers were disadvantaged in the Hybrid environment,” he says. “We weren’t able to represent clients electronically on the floor as we once did manually, and we couldn’t get the tools and order types we needed to compete with upstairs desks from the floor.”
As a result, both the exchange and floor brokers suffered, Willis says. But now, providing electronic tools to floor brokers to allow them to represent customers as agents is an investment the exchange can make in its own differentiation, he says. Floor brokers also represent large orders, Willis adds, so if they can execute through their handhelds, the exchange can print bigger executions and attract more volume that might otherwise get split up or sprayed out into the market. Cuttone agrees. “If more prints get on the tape,” he says, “customers will want to be protected on the floor. They will use floor brokers to make sure they can access that volume.”
Not Immune
The Big Board, with its market share below 30 percent in July, is no longer immune to this argument. The exchange doesn’t think floor brokers will resurrect the NYSE’s market share, but they could help shore it up. Larry Leibowitz, NYSE Euronext’s head of U.S. market and global technology, has acknowledged that the exchange, in a turnabout, must now seek to win order flow from those who once could trade only on the exchange’s floor.
Floor brokers are “free to go other places and hold us accountable,” Leibowitz said at a Security Traders Association of New York conference in April, chalking up the change to Reg NMS and the NYSE’s corporate evolution. “Traders view their orders as more portable than they were before,” he added. “Before, they were [exchange] owners. They might not have been treated as customers, but it didn’t matter. They were owners.”
The exchange has now begun catering to floor brokers as a constituency, along with concomitant efforts to make nice with specialists, upstairs brokers and high-frequency trading types. As part of this effort, the NYSE proposed a new market model to the SEC that tries to balance the competing interests of its many users in an effort to attract more market share back into its corner.
Specialists, soon to be called designated market makers, will lose some of their privileges as part of the NYSE’s sweeping effort to lighten their trading burdens so they can provide tighter and deeper markets. They will, for instance, no longer get a “first look” at incoming orders. Upstairs desks in May got reserve order functionality that previously only floor brokers and specialists had, giving them the ability to control their orders better. Last month, the exchange also began providing opening and closing order imbalance information electronically to upstairs and downstairs firms, although that information stream doesn’t include specialist and broker crowd interest.
The NYSE’s goal is to level the informational playing field for various parties, while giving specialists and floor brokers execution benefits designed to restore their ability to add depth and liquidity to the New York market. “A lot of what we’re doing from here on in levels the playing field, not only for brokers downstairs competing with brokers upstairs, but for brokers upstairs who are competing with brokers downstairs,” says Louis Pastina, head of floor operations at the NYSE.
For their part, floor brokers are now finally getting some of the trading tools they’ve been promised for months. The aim is to boost their ability to trade on the floor electronically the way they once did manually-or even to enhance that ability through technology. One new tool floor brokers got on their handhelds last month is algorithms that replace the CAP, or convert-and-parity, orders they formerly used to go along with NYSE trading. CAP orders, according to R&H’s Willis, never had the range of functionality floor brokers needed.
The key advantage of the exchange’s new algos is that they have parity. The algos, designed by Pragma Financial Systems specifically for NYSE floor brokers, with input from the floor community, include volume-weighted-average-price, percentage-of-volume and arrival price strategies. They will be supplemented by algos from vendor Deep Value this month. Michael Rutigliano, the NYSE’s floor liaison and a former longtime floor broker, stresses that the orders generated will be e-Quotes, “which provides parity for the algos and makes them one of a kind.”
Toward the end of summer, floor brokers are expected to get a complete suite of consolidated market information on their handhelds-which they haven’t had to date. And to facilitate more manual block discovery on the floor, the NYSE recently released a product on brokers’ handhelds called BlockTalk. That tool, essentially an indications-of-interest product, helps floor brokers draw out and identify liquidity in particular names without the intermediation of specialists. “This product gives the floor the ability to go back to its core value proposition–to attract, discover and price block liquidity in a very safe and secure way,” Rutigliano says.
Tiny Technology
However, not everyone is convinced the NYSE’s efforts vis-a-vis floor brokers will significantly improve the executions that floor brokers’ customers get-or improve the exchange’s market share prospects. Some see the NYSE’s focus on trading floor technology for floor brokers as a throwback to an old way of doing business. Electronic trading, the argument goes, has unleashed listed volume, and the New York, with its still-vast liquidity pool, should concentrate on building that faster-growing high-frequency piece of the business.
The NYSE’s changes to benefit the floor raise the “central metaphysical issue of the whole Hybrid experience,” says Jamie Selway, managing director at White Cap Trading, an upstairs institutional brokerage. “The trading world is not suited to people running about crowds with tiny pieces of technology.” In his view, it’s suited to traders upstairs, sitting comfortably in front of their screens, harnessing an army of information and technology to access liquidity in multiple locations.
According to Selway, NYSE Euronext CEO Duncan Niederauer and Leibowitz are giving the exchange’s constituent floor communities benefits just as they’re becoming less relevant in a broader limit-order-driven market. “They’re reinvigorating [those on the floor] by giving them special market privileges,” Selway says. “But if you give a new market-structure right to people who aren’t comfortable with technology to catch them up, it will be at the expense of someone else. The NYSE’s market share will go down.”
Fighting Chance
Most floor brokerages Traders Magazine spoke with don’t believe the NYSE’s market share will decrease once the exchange implements the changes it’s planning. But most aren’t betting it will reverse course and increase. Brokers whose main roost has always been the NYSE say they’re ready for whatever happens with the NYSE’s volume. The firms will trade upstairs as needed, they’ll trade Nasdaq stocks, and their business models will reflect the need to aggregate liquidity rapidly and algorithmically across ever-more venues.
WJB’s Rothfeld notes that his firm and others aren’t “incentivized” to go to the NYSE unless the liquidity is there, but will go there if the exchange has liquidity. Still, he hopes the NYSE can build a market model that attracts blocks and more floor trading. “If the NYSE can’t find a way to bring volume back to the floor in an electronic market, then they’re just another big ECN, no different than everyone else,” he says. “That’s what they’re trying to avoid.”
Floor brokers also stress that they’re far from shrinking violets when it comes to technology. Better tools that provide versatility and anonymity in accessing the NYSE market from the floor, they say, are what’s been needed all along. “There will always be winners and losers on the floor,” Rosenblatt Securities’ founder observes. “But with these new tools, more floor brokers will now at least have a fighting chance to make good on their assertions that they can offer better executions than their electronic counterparts.”
Rosenblatt expects floor brokers’ share of NYSE volume to increase in the near term as new tools allow brokers to represent their customers better. Still, he points out that he doesn’t care whether floor brokers’ portion of the listed-volume pie ultimately decreases. From his perspective, what’s important is that the exchange grows the absolute volume it trades. “It’s very possible that the agent’s share on a relative basis could shrink, yet agents could become more important and profitable because, on an absolute basis, they’d be doing a lot more volume,” he says.
White Cap’s Selway isn’t convinced. He speculates that the NYSE floor has hit a “medium-term bottom” in headcount and in its market share of listed stocks. But even he doesn’t expect the floor to fade away. “Long-term, there’s still a slow trickling away of people on the floor, but I don’t think the floor will close, maybe ever,” he says. “Duncan Niederauer wants the floor for the same reason the Chicago Mercantile Exchange wants the floor: It’s good marketing, some products have sufficient complexity to require crowd trading, some constituencies want it, and the exchange owns the building.”
SIDEBAR: Vanishing Floor Brokers
The common wisdom that floor brokers are a dying breed is at least partly true. Dozens of small and medium-size firms have disbanded in the last few years, or merged with other brokerages to create upstairs trading operations that can satisfy the needs of clients who can no longer trade on just the NYSE. Some floor traders have given up, or been pushed out as their firms cut their commission rate to attract flow that would otherwise go to algorithms. Some on the floor didn’t want the cheaper business, and didn’t want to function as human algos trying to beat the volume-weighted average price.
The numbers paint a stark picture. Three years ago, in mid-July 2005, the populous NYSE had 837 floor brokers and 2,475 clerks. At the end of last year, there were 412 brokers and 966 clerks. There are now 350 independent floor brokers at the NYSE.
The house brokers have by and large disappeared as investment banks, coping with fallout from the subprime crisis, cut back their floor operations to shrink headcount and expenses. Lehman Brothers exited the floor last year. Goldman Sachs, Morgan Stanley, Merrill Lynch and UBS have reduced the scope of their floor operations, eliminating house brokers and other personnel. Some have kept a handful of traders, and supplement them by using $2 brokers, now called independent agency floor brokers, to execute orders as needed.
The decimation in floor personnel took a toll on the footprint of the NYSE trading floor as well. The exchange has gone from five rooms to two: the Main Room and the Garage. And NYSE Euronext CEO Duncan Niederauer told analysts in May that, while he valued the floor and the differentiation it gave the exchange over the ECN model offered by Nasdaq and BATS Trading (not to mention NYSE Arca), he could envision a further compression to just one trading room.
And when it comes right down to it, the floor isn’t required. The NYSE in May said it planned to eliminate its backup contingency trading floor in MetroTech Center, Brooklyn. Should 11 Wall Street be unable to open at some point in the future, Big Board trading would shift, in an instant, to the Arca platform. That plan, which hasn’t yet been sent to the SEC, is subject to regulatory approval.
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