December 8, 2009

On the NYSE and Knight Floors

Denver is an icebox, so we went east to New York to warm up. Lovely here, the tree glittering at Rockefeller Center and the snowflakes magically materializing to music on the Saks & Co. façade. Festive!

Carmen Barone and the Barclays team graciously hosted me yesterday on the NYSE trading floor, and in the afternoon Marge Wywras at Knight Capital Group turned me loose with the traders on the Knight floor in Jersey City. That’s darned near a perfect business day to me.In reporting back to you on findings important to the IR chair, number one, floor operations play a crucial role still. These specialists, now called Designated Market Makers, are required to support issuers by actively placing bids and offers and committing their own financial resources. By wading into the stream of liquidity, 98% of which is automated on sophisticated mathematical systems, DMMs stabilize prices and help to foster orderly markets. Traders roam the floor with handheld devices controlling a variety of algorithmic options for working orders, which they deploy based on market conditions and customer preferences. They may follow the market, aim to affect a certain percentage of volume, aggressively push for alpha, and trade on a time-weighted or volume-weighted basis.

The floor revenue model has changed. Brokers are paid by the NYSE to provide liquidity, a form of rebate trading, which we’ve written about before. Just as grocery stores give out coupons to encourage customers to shop, rebates help exchanges and market centers attract liquidity from buyers and sellers, who then generate transactional revenue and data-services fees. The NYSE is supporting the DMMs by letting them collect fees that might otherwise go to super-fast market-neutral platforms, the high-frequency traders who own nothing and risk little in order to sit between buyers and sellers and churn shares back and forth.

The NYSE is stabilizing at some 25-30% share of traded volume now, down from the 85% (in listed issues) it enjoyed before the 2006 changes, but an improvement over recent pressure. The irony is that in an era of transparency, even the floor traders don’t know a great deal about the source and nature of the volume with which they interact. But they know a whole lot more than most. Our advice to issuers: make good use of their valuable access to market information.

My good friend Marge Wyrwas offered some eye-opening peeks behind the deceptively quiet façade of the building housing Knight Capital Group’s sleek trading operations. Wow. The floor is sliced up into sections providing sales trading, listed and Nasdaq equity trading strategies, ETF execution, bond trading, currency trading and even a new carbon trading operation. Billions of shares trade here every day. The degree with which Knight can knife through the maze and craze of equity trading and manage the execution of trades is really something to see. Two key takeaways: they do more real volume and less high-frequency trading than many think. And they blend the marvel of human insights with the magic of ultra-modern algo technology.

Personally, I was pleased to see again that we’re keeping right up with what’s happening. In fact, we’re tracking and clustering executed order flow to uniquely capture the nature and origin of liquidity in way that’s not being done, even at that trading level.

Why does all this matter? The IR role is an information role. Become the expert on market structure at your company and redefine the way IR is measured. It’s valuable to your management team, and cool to boot.

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