Regional exchanges primed for comeback after NMS

For a Factbox double click here [ID:nN26281735], for a Chronology click here [ID:nN26277225] and for additional stories in this series click here [ID:nN27397442] and here [ID:nN23499238]

By Jonathan Keehner

NEW YORK, Feb 27 (Reuters) - Sleepy regional exchanges could steal market share from leaders like the NYSE Group (NYX.N) as U.S. equity markets brace for dramatic new rules to take effect next month.

The much-anticipated Reg NMS, enacted by the U.S. Securities and Exchange Commission to update markets for new technologies, has already altered trading by precipitating venues like the Boston Equities Exchange (BeX) - an electronic market launched last year through a venture of large brokers and the Boston Stock Exchange.

"Reg NMS breathed new life into the regional exchanges," said Keefe, Bruyette & Woods analyst Richard Herr. "Of course they gain at another's expense -- in this case likely NYSE."

The most controversial feature of Reg NMS, adopted by a split SEC decision, requires execution of automated trades at the best available price. The rule bars so-called "trade-throughs," in which orders are executed at an inferior price even if better quotes are available elsewhere.

Under the new order protection rule, automated, or "fast," markets must obtain the best accessible price. Thus, the rule opens equity trading to electronic competition and may leave exchange floor quotes vulnerable to prices generated elsewhere, analysts said.

"The biggest winners in NMS are the regional exchanges because they are guaranteed a seat at the table," said Jamie Selway, co-founder of New York brokerage White Cap Trading, adding regionals give brokers alternatives that keep market leaders NYSE and the Nasdaq Stock Market (NDAQ.O) from gaining too much power.

Indeed, Citigroup (C.N) and Credit Suisse (XMEZ.DE), both BeX investors and top-ten NYSE brokers by volume, have also purchased equity stakes in the regional Philadelphia Stock Exchange.

Prior to Reg NMS, regional exchanges were largely ignored because they lacked enough trading volume to ensure a likely buyer for every seller, said Adam Sussman of New York consultant Tabb Group. Such volume is called liquidity.

Sussman also noted that regional exchange quotes could be traded-through.

"Now as long as it's a fast market everyone must go there," he added. "So we've seen a proliferation of brokers connecting to these exchanges and even taking ownership of them in preparation for Reg NMS."

PROTECTING ITS SHARE

But the Big Board, which last month handled its lowest-ever share of NYSE-listed trades, says trading volume at the exchange is growing and that a host of NMS-related services should help protect its share.

And of the new competition, NYSE Vice President Colin Clark points out: "It may not be that costly to create a new platform but you need captive liquidity."

Even if it continues to lose market share, NYSE should maintain market leadership with enormous liquidity, diversified products and an unmatched global footprint stretching into Europe and Asia.