The cost of capital depends, at least in part, on the cost of trading. The latter may soon become more competitive, thanks to the introduction of the Securities and Exchange Commission's Regulation NMS. Effective next June, the rule will require, among other things, that all stock orders be processed by whichever exchange can handle them electronically at the best price. For David P. Warren, the 51-year-old CFO of The Nasdaq Stock Market Inc., the ruling represents a great opportunity. Nasdaq has recently beefed up its electronic system by acquiring Instinet, another electronic system. Its archrival, the New York Stock Exchange, has countered by acquiring Archipelago, still another electronic system. In an interview with CFO, Warren outlines his views on the looming battle.
You've announced plans to leave the Intermarket Trading System (ITS), on which the exchanges ran for two decades. What are the benefits of leaving?
Our decision to withdraw in 2006 [when Reg NMS is implemented] reflects our thinking about the future. The ITS was created in 1978, and it's what holds the nine U.S. markets together. We felt, however, that the technology was slow and lacked capacity, and we wanted to establish our own private linkage because we see a trend away from traditional trading floors and toward automated trading. In addition, we expect that with Reg NMS, trading on an electronic system will grow exponentially.
Will your move force the other exchanges to build their own private linkages?
The implementation of Reg NMS gives them the permission. We're just taking advantage of it now instead of later. Do we think we've taken a first-mover step in this area? Absolutely.
Aside from setting up the private linkage, how will Reg NMS affect you?
Reg NMS represents a sea change in the U.S. equities market, specifically the order-protection rule: someone's order cannot be ignored if it's the best available price at the time. The other thing about Reg NMS is that it applies only to electronic markets. That's why New York is going electronic. We think we will be able to capture additional trading in New York–listed stocks, because more of that trading will happen on electronic systems, and we already have a very well-established system.
Is there any way to quantify how much additional trading you will capture?
Four months ago, we rolled out our own system as a pilot operation, and in that time we've had a 5 percent increase in the number of New York–listed stocks that we have traded over it. So there is a lot of potential to capture liquidity as well as volume.
Your acquisition of Instinet will give you additional electronic-trading capability. What else?
We will really come away with a trading system that, from a technological standpoint, will be second to none. It's also a lucrative deal for our shareholders, because in bringing [Instinet and our private linkages] together, we can derive the benefits of them without really bringing on any incremental cost.
Antitrust regulators are taking a hard look at your deal and at the NYSE's acquisition of Archipelago. Is there anything that could hold up approval?
In my estimation, Nasdaq/Instinet and NYSE/Archipelago are two very significant transactions in the equities market. Because they are transformational, the Department of Justice is looking at them with care. We are working through that process now, and at this point, there is nothing I can see that would suggest it is off course.
Once the deals close, what will differentiate Nasdaq from the NYSE?
There will still be differentiation in electronic trading. Whether it's a new type of order, a different way of posting an order, or a new way of controlling an order, we'll always try to look for ways to innovate. Last year, for example, we introduced a method for establishing opening and closing prices that more-accurately reflect the buy-and-sell interest in a particular stock.
We're especially excited about some of the new opportunities we're creating for our listed companies. Our Independent Research Network, for example, will help them get analyst coverage. Our insurance agency will help companies that are going public obtain directors' and officers' insurance. CFOs should frequently reevaluate their stock-market listing for what they're paying and the services they're getting.
Are we going to see more consolidation of the exchanges?
There will continue to be broad consolidation in the United States, but with respect to the ECNs [electronic communication networks], not much more can occur among the big players. But you can see some consolidation and innovation in the front end of the business among the "aggregators" — companies like LiquidNet that are working to develop strategies for block trades and other order aggregations. After the markets become a lot more electronic — and I'm speculating a bit — you'll begin to see the companies that have good electronic capacity in the equities market come together with those in the fixed-income market or the options market. It will be consolidation of different asset classes.
So much is made of the rivalry between Nasdaq and the NYSE. How do you characterize it?
The NYSE is a great institution, a great brand, and we compete very aggressively against it. It is a rivalry, but one in which the investor is going to be best served in the end.
Does it frustrate you that Nasdaq is always portrayed as fighting an uphill battle against the NYSE?
That's a misperception. I don't think we're fighting an uphill battle. I think we're fighting our own battle, executing our own plan, and doing very well at it.
— Interview by Lori Calabro