Electronic Communications Networks

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Electronic Communications Networks

• Marcus Woo
• Kevin Appel

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Activity

• Stock X
• Stock Y
• Stock Z

Person 1 represents a brokerage and has control
over 1,000 shares and have access to market
information Person 2, 3, and 4 are private
investors who have 100 shares to invest and only
know that all 3 stocks have been performing
stably. Assume that all stocks have the same
share prices.
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What is an Electronic Communications Network
(ECN)?

• Alternative Trading System
• Privately Owned
• Subscription Service
• Establishes anonymous and direct connection
  between buyers and sellers
• Accounts for 65 of trading volume of
  NASDAQ-listed shares as of 2005

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History of ECNs

• Technological changes
• Securities industry quick to adapt (SuperDOT)
• Instinet recognized as first electronic exchange
  market 1998
• Skeptical about lack of human interaction

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Trading on ECNs

• Essentially a limit order book
• Eliminates middleman
• ECN listed as contra-side party
• Smaller profit spreads (Buyer/Seller)
• ECN acts as 3rd party guarantor

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Benefits of Trading on an ECN

• Anonymity
• Lower transaction costs/errors
• Competitive pricing (transparency)
• Extended hours of operation
• Efficient transaction times
• Ability to pursue market makers

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Advantages of NYSE

• Preference ability and internalization
• More suitable for large stock orders
• Price improvement via the auction process
• No subscription fee for retail investors

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Regulations

• ECN serves a limited regulatory function
• Assume default risk
• NYSE Rule 390
• Heavily criticized and repealed on May 8, 2000

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Going public

• 1 billion class action lawsuit against market
  makers
• Maintaining high stock prices on open market
• Trading with each other at lower prices on
  Instinet
• Result ECNs open to the public

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Electronic Communications Networks Today

• Goldman Sachs
• Merrill Lynch
• Morgan Stanley
• J.P. Morgan
• Bear Stearns
• Salomon Smith Barney
• PaineWebber
• Credit Suisse First Boston
• Lehman Brothers

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Electronic Communications Networks Today

• Expand markets in which they hold investments
• Reduce volume of transactions flowing through
  specialist
• Cuts costs
• Involvement allows small-time investors access to
  ECNs

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Questions?