It's been less than a year since the STA's political action committee, STAPAC, was formed. Any progress?
AK: I think it's made tremendous progress. We've built our visibility in Washington. And [STA President] John Tognino is very good in that town. He knows what buttons to push in Washington.
The only failure of STAPAC is that we haven't marketed it enough to our membership. The STA needs to get the word out to its membership that STAPAC needs contributions. People in this business can be complacent to a certain degree.
How much money has STAPAC raised thus far?
AK: I would say about $150,000, all from member contributions.
Speaking about objectives, the STA seems to have focused more on their buy-side members in recent years.
AK: Definitely. It has to. A lot of our industry has gravitated to the buyside. It used to be that we would say the STA represents the market makers. But I think we represent the whole trading community. The buyside is as entwined in trading as the sellside. What affects us affects them.
That's why you have people like Holly Stark [head of trading at New York's Dalton, Greiner, Hartman, Maher & Co.] and Peter Jenkins [head of trading at New York-based Scudder Kemper Investments] working on STA committees alongside market makers. They may not agree with us at all times. But I think they understand that what affects the sellside also affects them.
Buy-side traders need to have strong relationships with sell-side firms, so they feel comfortable sending their orders to certain market makers for execution. The relationships in the industry may change with electronic trading and exchange consolidations, but you're always going to need relationships in this business.
You mentioned exchange consolidations. The Pacific Exchange and the Chicago Board Options Exchange have agreed to merge. The Cincinnati Stock Exchange and the Boston Stock Exchange are rumored to be in merger talks. The NASD merger with the American Stock Exchange [AMEX] and the Philadelphia Stock Exchange is close to approval. Is consolidation a wave of the future?
AK: Without question. Economies of scale is the name of the game with the exchanges. You're not going to be able to have eight different places trading the same stocks. You're starting to see some of the regional exchanges admit they can't survive on their own.
I don't think a lot of these exchanges have the money or the technology to grow. That's why they sign on with larger exchanges with deep pockets, to develop the technology to keep their business growing.
Are mergers among the regionals a threat to the New York Stock Exchange?
AK: What it does is maybe make the NYSE more competitive, and drive the costs of doing business down. Does a better marketplace surface as a result of the consolidation? Maybe. Maybe not. The NYSE is a tremendous organization with great leadership. Maybe they have to cut costs to the broker dealers or the customers as a result of the competition. They'll continue to maintain their market share, but maybe their margins will decrease a little bit.
Is this consolidation necessary?
AK: Yes. It is going to make for stronger markets going forward.
Is there a fear that too much of the order flow will go to only one or two exchanges instead of being spread around?
AK: I think that is one of the big issues today. But if you look at Nasdaq, I think that you have the opposite problem. There's fragmentation, and order flow is going to market makers, the ECNs [electronic communications networks], different crossing systems, and you've got to hope an investor has his order in the right place. The investor has to continually search all these places for the liquidity at each particular moment. Fragmentation is an issue being addressed on the listed side, but it's a real problem on the dealer side.
A person with an order can only watch so many screens and monitor so many liquidity sources. There has to be some technology changes and structural developments to match the changing market structure.
Some of the regional stock exchanges have developed innovative technology, but they lack the resources to develop it on a broad scale. Some of them have designed better mousetraps. But they don't have the order flow to build these mousetraps. Maybe with consolidation, they'll be able to do that.
How will the NASD's merger with the AMEX, an auction market, impact the Nasdaq dealer environment, if the two exchanges are ever integrated?
AK: Everything the NASD has said is that they will not integrate the two. They will run Nasdaq and the AMEX as separate entities. The NASD plans to install new technology on the AMEX to better compete with the NYSE.
If that is what happens, I think a lot of firms currently trading on Nasdaq will eventually have the opportunity to switch over to the auction environment of the AMEX. That's why it's crucial to fix the dealer market and level the playing field. Orders have to be traded fairly, and the market maker needs the same opportunity to make a return on his capital as his counterpart in the auction market.
The Actual-Size Rule was a huge benefit to the market-making community, and it's a start. But there is a lot still to be done.
The Actual-Size Rule, which was expanded in July, now allows market makers to quote all Nasdaq stock in minimum sizes of 100 shares. What's the benefit?
AK: It allows the market makers to commit their capital, when they want to commit it, with whom they want to commit it.
If market makers are trading high-flying, active stocks that can move dramatically in a matter of minutes, before the rule they could be long 4,000 shares and down a few points before they knew it. It was costing market makers a fortune.
Now, if market makers want to quote 500 shares or 100 shares, they can watch the stock and trade the stock before deciding to buy shares. Now it's their decision to commit capital, and that's the big difference. They can also decide who they commit capital to.
In the past, the market makers would be long before the natural sellers showed up. They'd already be caught in that stock, and it would be difficult to commit capital to the real sellers. Now, the market makers have a better chance of keeping out of trouble and reliquifying their positions. When the order comes in that they want to put their capital to, the market makers can make that decision themselves.
How will the NASD's proposed order-execution system affect trading?
AK: It will help level the playing field by letting market makers access the bids and offers on the ECNs without having to go through the convoluted, three-minute, SelectNet process. It's very difficult to access the market from a market-maker's standpoint, especially when stocks are in motion.
Do you support the proposal to create a limit-order book that is attached to the NASD proposal for a new order-execution system?
AK: I think the concept of a limit-order book in itself is probably a good idea. I don't think the NASD should design it and run it. The NASD has taken the limit-order book and tied it to the order-execution system. It has to be uncoupled. There is no way the two issues are the same.
You also have to do some forward thinking when looking at the limit-order book. Before you decide you should have a limit-order book, I think you first have to decide whether you need a trade-through rule, and you have to consider what affect the OptiMark Trading System will have, and you have to see how the different players in the marketplace will interact with the limit-order book.
And then it comes down to the issue of whether the NASD should compete with its member broker dealers and ECNs, or are the broker dealers and ECNs capable of handling limit orders.
Will the NASD separate the two proposals?
AK: I think they're going to have to.
What is the right way to build a limit-order book?
AK: I'm not sure I have that answer. You need a trade-through rule. You need to provide access to the book. I think you need to reward the people building the book. I don't think people should be able to take advantage of the book for nothing.
I look at the ECNs and certain market structures, and see that you pay for certain things. Why does a trader use [Reuters Holdings'] Instinet? If he's using it for anonymity, he should pay for that service. If he doesn't care to be anonymous, then he'll just publish his market on Nasdaq. Why should a trader have to pay an ECN when he doesn't care about its anonymity? But if he's paying for liquidity, then he should have to pay.
That's the way I look at the business. They should unbundle the services and let the market makers pay for the ones they want, and let them get paid for the ones they provide.
Are there too many ECNs out there?
AK: I think so.
Are the ECNs not adding value for the investor? Is there an ideal number of ECNs?
AK: I think they're adding value for the investor. But they are not being held to the same standards as the market makers. They are locking and crossing markets. It's like the Wild West. I know the NASD is looking at the issue. But there doesn't seem to be any rules or regulations the ECNs are being held accountable to. They can do whatever they want, which can create problems in the marketplace.
How can you say there are too many when the SEC says there can be as many as possible? My opinion is that the regulators would like to see the market makers on equal footing with the ECNs, with the ECNs contributing to a continuous market as much as market makers.
Unfortunately, the market maker has to be there every day, and the ECN doesn't.
So you think the ECNs should be regulated as broker dealers?
AK: Definitely. There should be new procedures for monitoring their order flow and regulating how they do business. Right now, I think the ECNs are unregulated from that standpoint.
What do you think of OptiMark or Instinet trying to get access to the Intermarket Trading System? How do you see the future of electronic trading?
AK: The future of electronic trading goes deeper than OptiMark and Instinet. They are just two parts of what is taking place in our market. One of the things I want to do as STA chairman is to continue to build the visibility of the STA so it can have an impact when it comes to the integration of these new developments.
One of the problems is that with the ECNs and the order handling rules, the playing field has been skewed tremendously away from the market maker. He's got to pay ECN fees. Accessibility to the ECNs is a joke. They can throw bids and offers out there, and the market maker can't get to them. And when he does get to them, they don't respond. They're not held to the same rules as the market maker.
One of my goals is to level the playing field next year.
How?
AK: The STA is in a strong position. If we can't get the NASD or the SEC to look at an issue, then we need to have the ability, visibility and credibility to file our own petitions and get the NASD and the SEC to address these issues.
We have to make sure the order flow going into Nasdaq is treated equally. Institutions and market makers need access to the ECNs, and the ECNs need access to market makers' bids and offers. But right now, if a market maker is not tied into a particular ECN, it's very difficult to get access to the orders it's reflecting.
The NASD has been trying to build their new order-execution system for Nasdaq, but for whatever reason, it keeps getting stuck in the mud. By the time the system does get up and running, it could be too late.