In 1792, under a buttonwood tree, 24 brokers created the New York Stock
Exchange (NYSE). The market was based on an outcry bid-auction model.
Over 200 years later, the system is basically the same, but there are now
thousands of traders that are buying and selling within a huge room.
Seems kind of, well, 18th century, huh? With the emergence of computers,
the NYSE has undergone market-share pressures. It really started with
NASDAQ, which is a huge network of computers.
There has also been a new phenomenon: electronic communications networks
(ECNs). These allow for quick and cheap trades using advanced computer
networks.
However, none are stock exchanges. Well, not yet. But it will
happen fast.
In light of these changes, the NYSE wants to go public. Actually, to
remain competitive, this is absolutely necessary. Unfortunately, the NYSE
announced yesterday that it will postpone its IPO to the middle of 2000.
A big reason for the delay is the Chairman of the Securities and Exchange
Commission (SEC), Arthur Levitt.
He thinks an IPO would present serious
conflicts-of-interest. You see, not only is the NYSE the platform for
trading securities, but also enforces the rules and regulations for the
exchange (known as a self-regulatory organization).
For instance, what if
the NYSE Inc. violates a rule? Who enforces it?
One idea is to create a “firewall,” which separates the exchange from the
regulatory department. This is similar to how things work at investment
banks, where the underwriting departments and research departments are
separated.
Or, the NYSE may spin-off its regulatory arm as its own entity. Perhaps a
better idea would be to merge the entity with the National Association of
Securities Dealers (which regulates the NASDAQ market), so as to create
efficiencies.
But, there are other problems with a NYSE IPO. For example, the NYSE is a
non-profit organization.
To go public, they’ll need to convert to a
for-profit organization, which is no easy task since the tax implications
can be horrendous. The IRS is expected to make a ruling on this.
Benefits of an IPO
Assuming the NYSE does an IPO, it can use its stock as currency to buy
other ECNs or exchanges, such as NASDAQ. After all, why do we need two
main exchanges?
Seems like lots of wasteful duplication. In fact, the
process has already started, with the merger of NASDAQ and the American
Stock Exchange (AMEX).
Moreover, the NYSE could purchase regional exchanges in the US, such as
the Pacific Exchange. The intended purpose of regional exchanges was to
deal with high-communications costs.
For example, at the turn of the
century, a long-distance phone call from LA to NY was extremely expensive. Thus,
it made more sense to have a regional stock exchange in LA. Of course, now
regional exchanges are an anachronism.
Finally, a NYSE IPO could allow for the purchase of international
exchanges. The future of stock trading is having 24/7 access around the
globe.
The Future
The role of a stock exchange is simple: liquidity. A buyer must be able
to readily purchase a stock and a seller must be able to readily sell a
stock — and not suffer wide variations in price.
The key to liquidity is centralization. This reduces search costs for
buyers and sellers. It also allows for better dissemination of information.
However, in our wired world, a stock exchange does not need to be
centralized geographically; rather, trades need to be centralized within a
sophisticated network of computers.
So the NYSE needs to do something radical, that is, get rid of its physical
trading floor and brokers.
If not, then there is another exchange that will win the war: NASDAQ,
which also plans to go public next year.
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