Electronic Communications Networks

Marcus WooKevin Appel

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.

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

History of ECNsTechnological changes

Securities industry quick to adapt (SuperDOT)

Instinet recognized as first electronic exchange market – 1998

Skeptical about lack of human interaction

Name Founded Location/Owner

Island 1996 Subsequently purchased by Instinet

Instinet 1969 Numera Holdings, Inc.

Archipelago 1997 NYSE

Brut 1998 NASDAQ

Redibook 1998 Spear, Leeds, & Kellogg

Bloomberg 1997 Bloomberg, LP

Trading on ECNsEssentially a limit order book

Eliminates middleman

ECN listed as contra-side party

Smaller profit spreads (Buyer/Seller)

ECN acts as 3rd party guarantor

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

Advantages of NYSEPreference ability and internalization

More suitable for large stock orders

Price improvement via the auction process

No subscription fee for retail investors

RegulationsECN serves a limited regulatory function

Assume default risk

NYSE Rule 390

Heavily criticized and repealed on May 8, 2000

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

Electronic Communications Networks Today

Electronic Communications Networks TodayExpand markets in which they hold investments

Reduce volume of transactions flowing through specialist

Cuts costs

Involvement allows small-time investors access to ECNs

Questions?