Market intelligence in a post-specialist world
Some say it all began with Bernie Madoff. As a young pre-felon, he merged a payment-for-order flow model with technology to devise a trading scheme that circumvented the NYSE’s venerable but privileged specialists. His competitive verve and entrepreneurial creativity was spectacularly successful, helping spawn the Third Market and NASDAQ. Over the years, Wall Street’s (and the SEC’s) continuing zest for competition has led to a succession of market structure changes that have further eroded the specialists’ market share and profitability.
Today, like Bernie, the specialist is no more. Unlike Bernie, however, the demise of the specialist is mourned by many. Chris Durkin is one. Formerly with an NYSE specialist firm, he now heads up IR and capital markets for a growing Chinese electronics company looking to trade its stock on a US market. Along with his CFO and corporate secretary, Durkin has just sat through a pair of meetings at NASDAQ and the NYSE, soaking in their respective pitches.
‘Each put on equally impressive presentations,’ says Durkin. ‘Each spoke about market fragmentation and market quality.’ But while Durkin’s bias would once have been clear, today he says his choice is less obvious.
‘We will now make a decision based entirely on cost and where we can find the deeper, more liquid market,’ he explains. ‘For a firm like mine, there is no IR information advantage gained from either exchange.’
A decade ago, Durkin asserts, working with an NYSE specialist offered a clear and dominant advantage. ‘Today, however, the information IROs need is simply no longer available,’ he points out. ‘Market fragmentation has benefited no one except those doing the fragmenting and IROs must live with it until these markets are fixed. As it stands, [market structure changes] have not put NASDAQ or the NYSE in a better position to service companies.’
‘With dark pools and all the algorithmic noise, the differences between the NYSE and NASDAQ are much less significant,’ agrees Diane Salucci, a former specialist company listing consultant and now principal of Salucci & Associates. She too laments the loss of an information environment featuring a market maker who saw 80 percent of trades.
‘It was a massive value proposition; I really loved having that one person who knew what was going on,’ Salucci explains. ‘Today, it’s still an advantage having someone actively watching your stock but he or she can really only spot retail trends.'
The mosaic theory
Indeed, in the rush to institute technology and competition into the market, issuers seem to have been far from the center of debate; and the information needs of IROs and their constituencies have been farther still. In 2006, before shedding its specialists, the NYSE moved to an open outcry/electronic hybrid system. But the advent of Reg NMS the following year forced it to radically redefine its market model, according to Joe Mecane, executive vice president and co-head of US listing and cash execution at NYSE Euronext.
‘Our primary goal was to maintain market quality while remaining competitive in a Reg NMS world,’ explains Mecane. ‘We tried to find a balance between the times it makes sense to be a purely electronic market and when it’s better to have a person involved in the transaction.'
Mecane points to the ‘flash crash’ as evidence of the latter. ‘May 6 was clearly a failure of broad market structure,’ he says. ‘But our market model prevented even more damage. In times of stress, purely electronic markets can break down.’
In tandem with its market model changes, the NYSE invested heavily in market data and analytics tools in an effort to piece together a ‘mosaic’ of information for IROs. The backbone of its service offering is NYSEnet, a website that gathers online proprietary and third-party trading data. It includes a popular automated and mobile-capable alert system connected to a desk of live experts on the ‘floor’ known as the Market Access Center (MAC).
‘Over the last two years, we have recognized this system as a key component of our value proposition,’ says Theresa Molloy, vice president of corporate client services at NYSE Euronext. ‘Issuers are struggling [with market fragmentation] and they still look to us as their de facto resource for market insight and intelligence.’
‘Around here, it’s all about databases and relationships,’ adds Rich Barry, vice president of NYSE Euronext’s capital markets desk. Besides assimilating information from more than 20 data sources (including information on technical analysis, options markets, dark pool activity and order book sentiment), Barry and his colleagues are in constant contact with floor brokers, designated market maker (DMM) firms and upstairs traders. ‘This complement of high tech and high touch provides a distinct advantage, meeting the needs of a large and diverse population of users thirsty for information,’ says Barry. ‘Our market structure still serves as a huge advantage in getting information delivered to IROs.’
Not so clear a picture
Still, no one is saying IROs can get the same definitive market insight as was possible when specialists presided over the auction of the lion’s share of a company’s stock. ‘Ten years ago, I was painting a hell of a picture for IROs,’ recalls one ex-specialist, now in charge of corporate relations at an NYSE DMM firm. ‘But with so much volume having hemorrhaged off-exchange, and in a high-frequency trading environment, it’s much more complicated to deduce what’s happening to your stock.’
Even so, as a DMM, he says he gets plenty of calls from IROs asking about just that. And while he sees less traffic, he says DMMs can still offer superior insight. ‘IROs seeking information from brokers who internalize orders may experience less than candid conversations,’ he notes. ‘Brokers don’t want competitors getting in front of their customers and stealing that order flow.’
The Wall Street veteran adds that while he can’t always tell IROs what they want to know, ‘sometimes, looking at a stock, you can just tell a large holder is using several different brokers to get out. Other times, trading activity is disguised so well that it flies under the radar.’
For its part, NASDAQ also offers a suite of services aimed at helping companies make sense of and respond to trading activity. But, as Demetrios Skalkotos, senior vice president of global corporate solutions at NASDAQ OMX, notes, ‘Fragmentation is making people do more work.’
In response, NASDAQ also aggregates multiple data feeds into its suite of services. ‘As the market changes, we are adapting to assist public companies in the new environment,’ says Skalkotos. ‘The puzzle is harder to put together but the pieces are still there. The key is making actionable the information issuers do have.’
There are signs the modest grist IROs have been putting to their mill may soon get more substantial. The SEC is rethinking its ‘democratization’ of US capital markets and perhaps also its stance on shareowner transparency. Following the flash crash and the apparent crisis of trust it created among US investors, debate on the specialist role (as well as that of NASDAQ market makers, who, for their part, have no obligation to provide quotes ‘reasonably related’ to the prevailing price) gained momentum.
SEC chairman Mary Schapiro has called on the commission to examine whether the loss of ‘old specialist obligations’ makes sense. Whatever form future obligations and incentives may take, companies and their IROs are hoping for a market structure model that is investment-driven, one where a company’s story drives the price of its stock.
In the meantime, what’s an IRO to do? Even as markets hurtle into the high-tech future, Salucci says IR must get old school. ‘However overworked they are, IR people will have to get on the phone and talk directly with their top investors,’ she says. ‘In the end, it’s the only way to understand what people really think about your stock.’