Wind of change blows towards New York Stock Exchange

NEW YORK - When the board members of the New York Stock Exchange gathered in private yesterday, they had much to talk about. In the next few months, the NYSE's management must make crucial strategic decisions about the world's largest stock exchange as it faces rising doubts about its relevance in the 21st century.

The so-called Big Board is housed in the heart of the fast-moving world of Wall Street, but many feel it is a relic of the past. Most of the 2800 stocks which are listed on the NYSE are bought and sold manually, by 3000 people in traders' jackets who rush around its trading floors, bartering with each other.

In contrast, neither the London Stock Exchange nor Liffe, the futures market, has a physical trading floor. Even the International Petroleum Exchange scrapped its trading floor yesterday to go electronic.

In New York, John Thain, the NYSE's chief executive and a former banker at Goldman Sachs, is well aware of the need for change. He was spirited in just over a year ago to replace Dick Grasso, the exchange's long-serving chief executive and chairman who was forced to step down following public outcry about his US$180m pay package.

Mr Thain's challenge is to rebuild the reputation of the exchange after the Grasso saga, where litigation is ongoing. But his wider task is to modernise the 213-year-old exchange.

Benn Steil, a fellow at the New York-based Council on Foreign Relations, pointed out there was a "historic logic" to the NYSE.

"Before computerised trading there had to be a physical place where people could get together and yell at each other," he said.

But that logic is long gone, and for its investors of today, the NYSE "is an anachronism".

While the NYSE's board does not disclose its agenda, undoubtedly up for discussion yesterday were the two projects Mr Thain has trumpeted as key to the NYSE's future.

They are automating much of the trading which passes through the NYSE, in order to create growth and vitality for the long term. And, as a follow-on, they would be considering ways to steer the privately held organisation towards an initial public offering.

At the moment investors can hit a button and trade a very limited amount - 1099 shares - electronically. The method accounts for nearly 10 per cent of NYSE trades.

Almost everyone agrees that increasing that level is a good idea because it should reduce transaction costs, speed the process up and encourage more trading to happen, making the market more liquid.

At the same time, there are plenty who argue - mainly those who are involved in it - that the human element offered by the NYSE in the form of the floor brokers who do the buying and selling and a group known as specialists, who set the price of stocks, should continue.

One of their key arguments is that specialists, who set the price and also buy and sell stock on their own account, reduce volatility, especially at times of crisis.

Mr Thain's answer is a hybrid system, which would remove the current cap on the size of electronic share trades, but would also route some trades through the floor. Such a system has never been tried before in equity trading in the US, and it is likely to take more than a year to implement.

Junius Peake, an expert on exchanges at the University of Northern Colorado, said he had read the detailed proposals for the hybrid market and found them "so complex I don't know how it can operate".

Yet Mr Thain and the group of people he has brought in to modernise the exchange have little choice but to press ahead with the hybrid system, because new rules being introduced by the Securities and Exchange Commission are in effect forcing the NYSE to make itself at least partially electronic.

Under an initiative known as Reg NMS, the SEC proposed last year that even though the NYSE tends to offer the best price most of the time, investors should be allowed to "trade through" to rival electronic markets such as Nasdaq or the smaller Archipelago.

Electronic exchanges usually do not offer the best price because there is no human bartering. But institutional investors particularly often prefer electronic systems because they are quick and guarantee anonymity.

The NYSE, in a panic about losing market share - currently 80 per cent of shares listed with it trade on its market - lobbied hard against the change. The result is a compromise.

The NYSE's fees from trading will fall as more trading is done electronically over the hybrid system, but a stickiness will also remain. As long as the NYSE offers the best price, investors will be unable to trade through to a rival electronic exchange.

The SEC seemed to go even further in the NYSE's favour this week, saying all markets must give investors the best price, even if that means going to a competing exchange to fill the order.

Supporters say protecting and extending the best price rule is good, especially for smaller investors because it will guarantee more transparency in the market.

There are plenty who disagree. Chief among them are institutional investors such as Fidelity, which says its millions of clients' pensions and savings would be far better served if its fund managers could decide where and how they wanted to trade.

While this debate rages, the exchange is considering another fundamental change: going public.

Mr Thain appears keen on flotation and has raised various possible areas of future growth which would be attractive to shareholders, including introducing trading in high-margin products such as derivatives, and opening the market earlier in the morning. A committee made up of NYSE members has been set up to consider a flotation.

First the exchange would have to move away from being a not-for-profit body, whereby earnings are reinvested in the organisation, to a new for-profit basis.

As well as attracting more capital to the exchange and giving it a currency in which it could make acquisitions in the future, going public would remove another core problem, which is causing major headaches for reformers at the NYSE who want to cut its costs and boost its profits. The obstacle is the fact that those operating at the exchange - the brokers and specialists - are also its owners.

If and when that changes, it is very likely that one of the first things to go will be the NYSE's historic trading floor.

- INDEPENDENT