See related feature: GETCO's Arrival on the NYSE Floor Raises Tensions on the Buy Side
The New York Stock Exchange's ability to attract GETCO as a designated market maker, or DMM, is a testament to the big changes the exchange made over the past two years to revive its market model and speed up its technology. As part of the effort, the NYSE eliminated the specialist function about a year ago and replaced it with the DMM role, paving the way for a new breed of electronic market maker, such as GETCO, a high-frequency proprietary trading firm.
While designated market makers still are the primary liquidity providers on the NYSE floor, they no longer have the information advantage or time-and-place advantage that they once had over other market participants. One of the major changes instituted by the NYSE was the elimination of market makers' "look" at incoming orders before they were displayed to the market. In exchange for giving up that advantage, DMMs instead now trade on "parity" with other exchange members, meaning they no longer have to yield to other liquidity providers on incoming orders.
"They're eligible to participate in the trades when they are at the inside price [i.e., the NBBO]," explains Joseph Mecane, the NYSE's EVP and chief administrative officer of U.S. markets, who notes that the DMMs earn the highest rebate from the exchange for providing liquidity. DMMs earn 30 cents per 100 shares, whereas supplemental liquidity providers, or SLPs -- a new class of market market that the NYSE established to provide additional liquidity and compete for market share -- earn 17 cents per 100 shares, provided the SLPs meet certain quoting, price and volume requirements.
To become an NYSE DMM, GETCO purchased part of the former NYSE specialist LaBranche's book of business from Barclays Capital. Barclays had acquired the LaBranche specialist business, which included 700 stock names, in January for $25 million but was asked to divest about half the book to diversify the allocations across the DMMs. Barclays was already responsible for 900 listed NYSE securities following the firm's March 2009 acquisition of the DMM rights of Bear Wagner Specialists from J.P. Morgan Chase.
Sources suggest that the NYSE wanted to bring in a strong player to boost the liquidity of the DMMs, and word on the Street is that following the NYSE's makeover, GETCO was interested. GETCO already was an SLP, along with Goldman, Barclays Capital, Knight, Citadel and recent entrant Virtu Financial, another high-frequency proprietary trading firm. (According to the NYSE, in March DMMs' participation was 8.5 percent of NYSE-listed volume; SLPs matched 11.4 percent of NYSE-listed volume.
'A Different Business Model'
"It is a different business model than it historically was," observes Joseph Cangemi, managing director and head of equity sales and trading for ConvergEx Group's global electronic trading unit. "What you're seeing is a passing of the torch from a [specialist such as LaBranche] that was more suited to the other market structure, to the firm that is more suited to an electronic, fragmented, high-speed market structure. [GETCO] has technologies and speed that match the present day market structure."
Now that NYSE trading is 90 percent electronic via automated algorithms, GETCO can run its sophisticated models and automated market making, suggests the exchange's Mecane. Technology changes at the NYSE reduced latency on the exchange from 105 milliseconds just a few years ago to five milliseconds in July 2009. And the next platform iteration "will bring us below a millisecond," Mecane says.
The timing was right for GETCO, acknowledges Dave Babulak, the firm's managing director. "NYSE made a lot of investments in technology and a lot of modernization of their rule set, and this really enabled us to take what we've been doing in the electronic world and make this useful on the floor," he relates.
"This is good for the NYSE, and it will experience a market share boost in the names in which GETCO is the DMM," comments Rosenblatt's Gawronski. "If the NYSE is paying a higher rebate to GETCO [as a DMM rather than an SLP], it means GETCO will be able to make better prices for investors."
According to published reports, NYSE Euronext's share of NYSE-listed trading volume (including both NYSE and Arca) had risen from 37 percent in August 2009 to 39 percent as of February, suggesting that the combination of faster technology and economic incentives for automated market makers is working. But the NYSE's Mecane isn't ready to declare the move a major success just yet.
"I'm not going to sit here and predict a dramatic improvement," he concedes. "It certainly won't hurt market share. I think it will be a positive -- certainly a step in the right direction."