| Antoine Shagoury |
“Trading is a commodity,” says Antoine Shagoury, the American Stock Exchange‘s chief information officer and the leader of its hybrid market initiative. So exactly how flexible and how adaptable can an exchange be when it comes to its singular asset? How AEMI – which stands for Auction and Electronic Market Integration – answers those questions could determine the troubled exchange’s future. AEMI is Amex’s effort to bring it into the post-Regulation NMS world, and to take advantage of this new electronic era. The new system will trade equities and exchange-traded funds at first, but will eventually trade options and fixed-income products, probably next year. “We’re not adapting” the Amex trading system, Shagoury says confidently. “We’re replacing it.” The Amex has its sights set squarely on the future.
Amex’s dedication to its future is inextricably linked to its difficult past. The last decade hasn’t been a great one for the nation’s third largest exchange. Purchased by the National Association of Securities Dealers – at the time also the owners of the Nasdaq Stock Market – at the end of 1998, the hoped-for synergy between the two exchanges never materialized in spite of an optimistic new moniker, the Nasdaq-Amex Market Group. Little more than two years later, the NASD decided to focus on its regulatory role, and Amex was back on the block.
But there weren’t any takers: Rumored hookups with the New York Stock Exchange, Hong Kong Stock Exchange and Philadelphia Stock Exchange never panned out. In December 2004, the NASD finally sold the exchange back to its members after six unhappy years; all the while, the Amex’s market share, in equities, ETFs and options, continued to dwindle.
Looking Forward to the Past
The all-electronic International Securities Exchange overtook the Amex for second place in options volume in 2003; last year, the ISE won more than twice the volume of the Amex. Nor can the Amex be assured that third is a place it can keep, with one-time suitor Philadelphia Stock Exchange nipping at its heels, besting the Amex over the last three months. Indeed, in January, the Amex fell to fifth place, behind both the Phlx and the Pacific Exchange, the latter owned, of course, by the NYSE Group. In equities, things haven’t been much brighter: Its equities volume fell 3.6% in 2005, while it’s rival on Wall Street saw its volume rise 10%.
| Neal Wolkoff |
As the Amex and the NASD worked to close their divorce, the exchange’s top leadership found itself in regulatory limbo. As part of its investigation into order-handling at the Amex, the Securities and Exchange Commission slapped then-Chairman and CEO Salvatore Sodano, then-President Peter Quick and then-general counsel Michael Ryan with Wells notices (notification issued by regulators to inform individuals and companies of completed investigations where infractions have been discovered) in November 2004. Sodano resigned in January 2005, replaced by Neal Wolkoff, a former New York Mercantile Exchange chief operating officer; Quick followed Sodano out the door in May. Shagoury – formerly the chief technology officer at electronic communication network Instinet, which has since been acquired by the Nasdaq – joined the Amex in his current role in August 2004 after a year serving as a technology consultant to the exchange. He entered just months after AEMI development commenced, and only months before the regulatory fireworks started going off.
With the June 29th Reg. NMS implementation deadline looming, the exchange’s CIO could not sound more confident. Feature development is 90% completed, he says, adding that if the Amex is “not tier one in trading, it’s tier one in technology.”
AEMI, Shagoury says, will offer users “the best of both worlds.” In other words, instant electronic execution for the overwhelming majority of trades, qualifying it as an “automatic trading center,” or “fast” market, while maintaining a role for its specialists, market makers and floor brokers in its auction market.
Wolkoff has said he expects about 95% of trades on the Amex to be of the instantaneous electronic variety, and told InstitutionalInvestor.com that “AEMI is as fast as any [electronic communication network].” Automatic execution will be suspended, and the floor will step in, in cases of high volatility, large imbalances and system failure. Customers can also opt for floor representation or auction representation instead of auto-ex. Shagoury is in no doubt that, in many cases, they will.
The Amex specializes in listing small- and mid-cap companies, and prides itself on a commitment to helping smaller companies grow. But small-cap stocks are not known for having exceptionally deep liquidity.
“We have something really special at the Amex, and that’s the auction market, with a commitment that systems and computers can’t duplicate,” Roland Savage, a partner with Amex specialist firm AGS Specialists, and a former Amex executive, told InstitutionalInvestor.com. “The concept of electronic trading, speed and electronics to the exclusion of the human element and the capital commitment is problematic for certain issues.”
But it’s not only small-caps that Shagoury sees benefiting from an auction marketplace. Though the Amex intends to qualify as a “fast” market, Shagoury accepts the notion – one put forward at the time of Reg NMS’ implementation by the Nasdaq, ECNs and some big institutional players – that speed is not necessarily the single most important thing for a client. To those clients, he offers the auction space.
“There is a fundamental market for the more complex orders, for the imbalances, for the complex trades,” he argues. With AEMI, Shagoury says, “we can now help [clients] compete on both sides. We’re now giving them the right tools to actually work and interact in the market place.”
Uphill Battle
Those arguments don’t, however, convince everyone, especially those dubious that Amex can make the kind of comeback they need to to recover their share of the market.
“The equities market is not so complicated that a hybrid market is needed,” says Sang Lee, managing partner at the Aite Group in Boston. “If you look at the global trend, the floors are losing.” Though he concedes that a specialist-driven market does lend liquidity to less-liquid issues, he notes that these stocks are illiquid for a reason. “If no one wants to trade a stock, then it’s not going to be traded.”
Most of the Amex’s order flow, however, will go where Reg. NMS intends it to: the electronic book for immediate execution. It’s there that Shagoury’s real ambitions come to light: AEMI is not merely a ploy to meet with regulatory approval and cling to the exchange’s shrinking market share. It is designed to reverse years of decline in market share.
To that end, Shagoury says, Reg. NMS offers the Amex a golden opportunity. “If I can be as fast as an ECN, if I can provide the certainty of execution that the investors are looking for in that space, if I can be as competitive in cost or in price, under the new Reg. NMS structure, orders have to come to me, so I can compete and I can gain order flow.”
Indeed, one of Reg. NMS’ more controversial steps was the extension of the controversial trade-through rule – widely seen as favoring the NYSE – to electronic markets, forbidding them from ignoring a better price quoted on another exchange. AEMI “is not to hold on to what I have,” the former Instinet CTO says, “this is to grow new business.”
Lee says the Amex’s efforts are misplaced. “There’s absolutely no reason why introducing a new platform will attract additional liquidity” to beat the ECNs at their own game, he says. “Technology is almost secondary. You need to have liquidity first.”
Shagoury counters that his mandate is to make Amex as competitive as it can be, across purely electronic marketplaces as well as the auction marketplace. “Given the way we’ve been able to bind these two processes together, I think we can show a benefit to our members and to investors,” he says.
To that end, Shagoury is looking in two directions: to the floor, and to another floor a few blocks away. With AEMI, he says, “We will have a better system than NYSE.... Definitely, I’m better.”
Better than what might is not necessarily an easy question to answer. While the Amex’s rule filing for AEMI has been revised once and amended once so far – Shagoury says “the SEC likes what it sees” – the NYSE’s proposal for its hybrid market has been amended seven times.
“The first version of it was still favorable to the specialists and brokers,” says Aite’s Lee, “but there were a lot of restrictions around what they could actually do within the marketplace.” With each amendment, you see those restrictions being literally stripped away, to the point where the entire market may actually resemble the current market, just in electronic form. Lee puts the odds of the NYSE’s hybrid market seeing the light of day at 50/50.
With the uncertainty surrounding his much larger neighbor’s plans, Shagoury says confidently, “We’re going an extra mile compared to our competitors.”
Shagoury did not only have the NYSE in mind when putting together AEMI. He’s also at the mercy of his bosses, the new owners of the Amex – its members.
As noted, these are not the most comfortable of days for floor traders and specialists, viewed by many as unnecessary relics. And, as AGS’s Savage says, “with any new system that’s being put into place, everyone’s going to have some questions.... People always assume its going to affect them in different ways.”
Brave New World
Shagoury acknowledges the trepidation many on the floor feel in this brave new world, but argues that even they see the writing on the wall. “Change is always difficult for traders,” according to Amex member Peter Doyle, president of execution firm Pro-Ex LLC. Savage, with 25 years at the Amex under his belt, says that for the most part everyone accepts that exchanges are operating in a new environment.
“A lot of traders that I’ve talked to are embracing [AEMI],” says Doyle, who has more than 20 years on the floor, “because this is our best shot at a future.”
What they’re not allowing, of course, is extinction, but Shagoury and Wolkoff don’t think they have to. “You’ll never see us move away from the floor,” Shagoury says, adding that, “if there weren’t demand, we’d get no order flow.” Maintaining his ever-positive stance, he is not predicting a fall off in floor trading under AEMI, only new business.
To earn that new business, Shagoury, Wolkoff and the Amex have a tough road ahead if they are to convince the market that they have turned the page from an excessively conservative past. But the looming question remains – have they?
“From a competitive perspective, [a hybrid market] doesn’t make any sense,” argues Lee. "[Amex] is a third-tier player in this marketplace, with shrinking market share; at a certain point, [it] has to take risks.”
Lee says he likes the moves taken by the Phlx: Last year it demutualized and sold a stake to Merrill Lynch, and this year it plans to shutter its equities trading floor. “I think [the Amex] should have seriously thought about launching a fully electronic platform, becoming for-profit and taking more chances,” Lee says. “You can’t continue along your current trajectory if it isn’t working.”
Much of Lee’s criticism stems from the fact that he is still unsure of how decisive a break the Amex’s new regime is with its past. But Wolkoff believes that’s unfair. “We now have a clear direction,” he says. “We have a change in management, a new board and we have adopted a business plan.... We have become a customer-centric organization.”
Shagoury says he understands the skepticism, though he, as you might expect, disagrees: “I cannot dispel anyone’s misconceptions until I launch that system.... The proof will be in the pudding. When we deliver, people will realize that this is being taken very seriously here.”
Even its most serious critics hope that Shagoury is right. “Amex has done a tremendous job in terms of product innovations,” Lee says. Asked if he thought the exchange’s moves were a case of too little, too late, he says, “I hope not. It’s a shame for an institution like this to disappear to a certain degree, and lose some of its glitter.”
AEMI is almost ready to try to restore some of it. Does she have what it takes?