Speaking of the Nasdaq...

January 18, 2008

In Matt's mention of the NASDAQ, he does not mention one of the more interesting aspects of the NYSE purchase: NASDAQ's own failed merger with the Amex.

This deal has long been talked about (and most people I know thought it would never happen), but here we are, the NYSE buys the Amex. With ETFs clearly being at the core of the deal, and knowing both sides and all the trading issues, I've got a lot of different thoughts running through my mind on this.

First of all, it depends on how things are organized as to who this will make the biggest impact on. My immediate response is the biggest changes could be to the service level for ETF product issuers, and to the quality of markets for investors in the less-traded ETFs. Those are the areas where competition and specialist oversight, respectively, may be reduced. 

The Amex has long been noted for the high level of attention it pays to product issuers. They lend expertise particularly in the ramp-up process for new product issuers, helping them with the structural issues, and to get connected with all the right people to make the products run well. After all, the Amex did bring the first ETFs to market. Historically, the NYSE and NASDAQ are leaner and more market- and technology-focused—the Amex's weaker points.

Which leads us to specialists. NYSE/Euronext has already moved the bulk of the ETF market onto the Arca trading platform, completing the natural trend toward more electronic trading in ETFs. The argument goes that with ETFs, because price discovery has already happened with the underlying, there's no better area to go fully electronic. And in theory this is true. In practice, however, the move toward electronic trading has not always been so smooth (see the NASDAQ-listed BLDRs when they came out). As with the BLDRs, my sense is that generally market forces have worked out and will continue working out the kinks in electronic trading. And overall, the more open markets are, the better that is for the end user. Look at how spreads have come down in the ETF industry. It's amazing. And that's largely attributable to the move toward electronic trading.

Where I do have concerns, and the area the ETF industry has always downplayed, is what happens in the most lightly traded ETFs.  The line has always been that it's ALL about the underlying in terms of liquidity. And that's absolutely true if you're an investor of (say, creation-level) size. But if you're trading a couple hundred shares, if there's no one at the switch, you could get a market fill that's well off the NAV. Essentially, the financial incentive is just not there for larger players to competitively arbitrage at smaller size. But Joe Chompers in Des Moines still can do it. I don't want to blow that issue up into something larger than it is, but it is an issue, and you see it in European electronic markets as well as in the U.S. This is an issue that is worth some study by us as things move forward. The first question will be whether all the Amex ETFs move to Arca, or whether some semblance of a specialist system stays in place.

So that's most of what I'm thinking regarding the Amex. It's kind of sad—the end of an era—of the trailblazing Amex ETF guys. Well, it's the end of an era unless there's some kind of culture-clash blowup that backs Amex out of the deal as happened with NASDAQ—but I think that's very unlikely.

By the way, Cliff Weber—I respect you all the more. You HAD to have been right in the middle of that deal when you came down to our conference and spoke. And then, to make things worse, you didn't have enough of a chance on your panel to get into the details of structured products ... an area where you and the Amex have been real leaders and innovators. So thank you, Cliff (and also Lisa Dallmer, who was probably also in the middle of it) for coming. And I'm sorry for annoying you with all my questions about the deal (which you obviously could not answer).

These are exciting, crazy times. And really the only ones out there outside the industry who can keep track of the implications of all this market structure movement to the ETF business are us. We'll try to do a decent job of it. They're big issues.   

By the way I went into Matt's blog yesterday and did some badly needed copyedit. He had a line about "Unlimited Trading Privledges (UTPs). Ahem, that's Unlisted Trading Privileges. Good lord—can we get a copyeditor around here who speaks ETF, or even English? 

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