The impact of Electronic Communications Networks ECNs on

The impact of Electronic Communications Networks (ECNs) on NYSE Presentation to Mr. Richard Grasso and NYSE Directors SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 1

Agenda • • • ECNs – What they are / History and growth Strengths and Challenges Threats to NYSE Takeaways Questions SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 2

History and Growth Instinet, the first ECN, was created 1969 Increased technology allows for greater capacity and efficiency 1970 1990 SEC Order Handling Rules triggers growth 1996 2001 9 # ECNs 1 SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 3

ECNs have 30% of trading volume in Nasdaq Trading Volume in Nasdaq REDIbook Archipelago Others ECNs 30% Instinet 70% Island Source: CSFB report SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 4

ECNs - What they are • Bring buyers and sellers together for electronic execution of trades. • Have a wide variety of subscribers, including retail investors, institutional investors, market makers and brokerdealers. • Allows subscribers to trade between themselves without having to go through a middleman • Are alternative to formal Stock Exchanges (NYSE) or to dealer makers (NASDAQ) for trading securities SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 5

How NYSE and ECN Transactions Differ Investor Own Inventory Brokerage firm A Specialist Brokerage firm B IT System ECN Investor ECN SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 6

Limited orders SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 7

Strengths of ECNs • Anonymity (Signaling) Ø • Commission Structure Ø • Reduced from $. 06 to $. 03 per share More efficient (Speed) Ø • Information leakage is greatly reduced Orders post instantly versus wait up to three minutes Neutrality Ø Removes conflicts of interest in trading for own accounts SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 8

Strengths of ECNs (cont. ) • Transparency Ø • ECNs post size and price of customer orders After hours trading Ø ECNs offer an attractive venue for trading outside normal trading hours SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 9

The Challenges Facing ECNs • • Liquidity Ø How to retain and attract volume Ø The greater the volume of transactions, the more likely trades will be executed successfully Ø Routing trades to other ECNs Ø Partnering with brokerage firms for order flow Differentiation Ø An exchange that provides superior transaction processing Ø Or a value-added broker that offers a range of products SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 10

The Challenges Facing ECNs (cont. ) 1. Increased Regulatory and Compliance Demands 1. Regulation ATS (Alternative Trading Systems) 2. SEC Broker Dealer Regulations 3. Exchange Specific Regulations 2. Integrity 1. Building an ethical reputation 2. Excelling in treatment of customers 3. Technology 1. Continual upgrade requires substantial investments SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 11

Why ECNs have had limited impact on NYSE • Reluctance of traders to change trading places • Better economies of scale through larger volumes per orders • Better liquidity • Automation of trading posts • NYSE Direct + (limited orders smaller than 1, 099 shares) SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 12

Threats to NYSE • ECNs are merging to obtain benefits of network effects • If they are able to differentiate they can obtain Ø Market share Ø Profits inequality SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 13

Threats to NYSE • Full automation of NYSE would cut trading costs and reduce cost of capital to firms Cost Reduction The power of automation Trading Cost of capital 27 % 4. 2 % Source: The Economist SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 14

Threats to NYSE • • • Exchanges around the world are merging Achieve economies of scale Get order flow to increase liquidity Reduce fragmentation Improve automation Eg. Ø London Stock Exchange + Deustche Börse = i. X Ø i. X has signed a JV with Nasdaq SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 15

Threats to NYSE • Archipelago has obtained approval to become first ECN -based national stock exchange • Participants can trade NYSE, AMEX listed stocks, as well as Nasdaq shares • Archipelago can connect with other exchanges through the Intermarket Trading System and collect fees for data access SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 16

Takeaways 1. ECNs have consistently increased volume share 2. ECNs have made inroads into the Nasdaq and into the European market 3. ECNs are changing the way that security markets conduct business 4. NYSE has remained the dominant player but will need to address its own capabilities to remain the market leader SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 17

Questions? SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 18

Supporting material SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 19

NYSE business Market capitalization has increased at the NYSE… # companies listed = 2, 800 Market Capitalization ($trillion) # companies listed = 1, 769 Source: The Economist SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 20

NYSE business … and so has the American passion for equities % of adult population that owns shares % Source: The Economist SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 21

NYSE business The automation of trading posts in 1999 has brought substantial benefits to the NYSE … u Increased volume u Additional sources of market information for specialists and brokers u Better visibility to institutions and investors u Enhanced liquidity … however, ECNs can present a threat to NYSE SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 22

Who are the ECNs and which services they provide How ECNs operate with Nasdaq Subscriber Non Subscriber Nasdaq Select. Net ECN Non Subscribers access ECNs via Select. Net SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 23

Trends and Threats In 1986 London Stock Exchange introduced a screen-based quotation system (SEAQ) Daily volume (in $Billion) LSE NYSE Big Bang SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 24

Attachment 1 - Automation of Trading posts u Post Information displays u Flat panel display screen u Point-of-sale workstation u Wireless data system SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 25

Attachment 2 - The network effect # of firms Sales of largest q 1 Sales of second q 2 Sales of third q 3 Profits of largest p 1 Profits of second firm p 2 Profits of third firm p 3 1 0. 6666 - - 0. 2222 - - 2 0. 6357 0. 2428 - 0. 1726 0. 0294 - 3 0. 6340 0. 2326 0. 0888 0. 17007 0. 0231 0. 00035 Source: The impact of the Internet on financial markets Nicholas Economides SAO XX-00 XXXCASE NUMBERSUBDIRFILE NAME. PPT 26