Taking the Hybrid Road

The world is watching as the New York Stock Exchange (NYSE) and the American Stock Exchange (Amex) begin to deploy their hybrid trading systems. Until recently, working to meet the SEC's Regulation NMS deadlines only occupied the time of developers and programmers. As the June deadline approaches, traders on the floor are beginning to feel the effects of the changes.

Traders and specialists on the NYSE received an early Christmas present from the Big Board as it launched the first phase of a four-phase pilot of the NYSE Hybrid Market trading system on Dec. 15, 2005. The NYSE expects the pilot to last 90 days, or until the SEC approves the exchange's new trading model.

"When we set this plan out, we looked to introduce functionality to the brokers first, specialists second, and all of the other features of Hybrid in the third component," says Lou Pastina, senior vice president of market development for the NYSE. "The last component will include the requirements from the SEC."

The pilot kicked off with the specialist firm Van der Moolen making a market with one test stock. At press time, the NYSE has rolled out 19 additional test stocks and expected to have the traders and specialists trading the complete set of 168 test stocks by mid-January.

Among the new features introduced in the first phase is the e-Quote, which is an electronic method that floor brokers can use to place bids and offers on the specialists' order management systems (OMSes), known as the Display Books, via the brokers' handheld displays. Specialists can enter their trading interest into the Display Book either algorithmically or manually. During the pilot program, specialists will only be able to enter their orders manually.

Floor brokers will need to tweak their existing systems to connect to the Hybrid system during the first and third phases, says Pastina. He says most of the heavy lifting is being done by the exchange because it provides the Booth Order Management Service and handhelds to a majority of the floor brokers. "We represent 700 of the 900 potential brokers on the floor in the terms of handheld coverage," he says. The NYSE began addressing these connectivity issues in late 2004 by building specifications, coding, testing and providing a test environment.

Many of the 700 NYSE-supported handhelds are already completed, says Pastina. "As we roll out to particular securities, we make sure that the brokers in those zones are upgraded and are ready to participate in the pilot. I expect that by the end, every NYSE handheld will be updated," he says. At press time, the updates were slated to be complete in mid-January.

Those firms using proprietary handheld solutions, such as Bear Stearns, Citigroup, Credit Suisse First Boston and Goldman Sachs, or relying on a third-party provider, such as Nyfix, will need to upgrade their software on their own to have the e-Quoting capabilities during the first phase. "We've had the other providers in our test environments for several months now," says Pastina.

Many industry watchers are taking a wait-and-see approach before passing any judgment on the pilot program.

"The first phase looks at the functionality for the floor brokers and the specialists," says Sang Lee, managing partner and analyst with the Boston-based consultancy Aite Group. "The really revolutionary part will be on the other side, lifting the limits on NYSE's automatic execution service, Direct+, and figure out how these two will interact."

Pastina says the mood at the exchange is upbeat about the initial success. "The software has worked the way it was supposed to work," says Pastina, adding that feedback from brokers and specialists indicates that they find the platform very intuitive. "It's allowing us to proceed with the pilot to other locations."

The NYSE is chomping at the bit to move to the specialist-centric second phase that would let the specialists connect their computers directly with the exchange's computer, allowing them to enter quotes electronically. Now, the NYSE is waiting for the SEC to sign off on the exchange's pilot project.

"We haven't been approved yet fully for Hybrid," says Pastina. The exchange filed its request for approval 22 months ago and made several amendments to its filing as the Hybrid project evolved. "That is the reason for the pilot request—so we could get started," he says.

While it waits for approval, the NYSE would like to have as much as time as possible to perform a shake-out cruise before going live with the new platform. "There's always a concern that software won't work as planned," says Pastina. "You can never really predict what is going to happen. You do as much testing as you possibly can, as much training as you possibly can, and then you go live and hope for the best."

What happens if the Hybrid system isn't fully baked in time for the Reg NMS deadline? Pastina acknowledges that if issues do pop up, the exchange would deal with them swiftly. "We'll raise our hand and say that we have issues and that we have to deal with them. Right now, that hasn't been the case and, hopefully, that won't be the case going forward," he says.

Meanwhile, a block away from NYSE, the Amex is taking a different route to integrate its floor-based and electronic-based traders, using its new trading platform dubbed Auction and Electronic Market Integration (AEMI).

"Unlike the NYSE, which is adding functionality to its existing trading system, AEMI is a new trading platform," says Antoine Shagoury, the CIO of Amex.

The Amex began its initial effort to develop its pure electronic hybrid trading systems in November 2003. From the beginning, the exchange explored the business requirements that the new platform would need to support. By September 2004, Amex started including feedback from its floor community into AEMI's development and officially sought the exchange board's approval to pursue the development of the new trading system.

"We didn't front-run Reg NMS," says Shagoury. "This was the best value proposition for the exchange."

In the spring of 2005, Amex began the development of the new platform.

"The past year has been a development year and a production-ready year," says Shagoury. "This past summer saw the development of the base system and we have been adding functionality releases on a monthly basis."

Shagoury estimates that AEMI should be ready this month. "That's when we go into the use acceptance and final quality assurance phase," he says.

At press time, Amex was set to go live with a new primary data center to support AEMI by the end of January. The secondary data center is expected to go live by March. Similar to Nasdaq's decision to migrate its secondary data center to a hosted facility in the first part of 2005, both new data centers will be located in hosted facilities.

"Nasdaq collapsed infrastructure and reduced staff, but we're reducing infrastructure and adding staff," says Shagoury, who points out that the Amex has tripled its technology staff and reduced the number of contract workers on which it relies. "We're not trying to drive efficiency through our operations, but rather through our trading system."

Amex will wind down its current data centers once the SEC has officially signed off on AEMI.

"This is an entirely new platform," says Shagoury. "It's a radical departure in that we changed from the Hewlett-Packard, DEC and VMS platforms to Linux-on-Intel, which is horizontally scalable."

Throughout the development and testing process, Shagoury's team has been able to remain true to the schedule. "Any slips we had can be measured in days, not months, and were quickly caught up," he says.

When will the general public be allowed to take a peek at AEMI? According to Shagoury, there is no pilot schedule because none of the other market centers linking to AEMI are prepared to run under the Reg NMS guidelines yet. "The pilot will probably be done with the pilot run of Reg NMS, which should occur between April and June," he says.

Although AEMI sports a bright shiny face, it hasn't won the favor of some industry watchers.

"My beef with all of the non-NYSE exchanges is that they're following the NYSE's footsteps," says Lee. "The NYSE had to go with a hybrid model because it had no choice. For them, it was about internal politics. The NYSE wasn't about to tell the specialists to shove off and close its trading floor."

The Amex representative quickly dismisses the comparison between itself and the NYSE. Shagoury points out that that a hybrid system is the logical way to integrate the high-touch needs for illiquid stocks and the low-touch needs of the highly liquid ones.

"The floor is at an important point in its evolution," says Shagoury. "Yes, there will be new faces on the floor, but it's not going to be going away. There's too much value to the trader, broker and to the end investor."