Electronic communication network
An electronic communication network (ECN) is the term used in financial circles for a type of computer system that facilitates trading of financial products outside of stock exchanges. The primary products that are traded on ECNs are stocks and currencies. ECNs came into existence in 1998 when the SEC authorized their creation. ECNs increase competition among trading firms by lowering transaction costs, giving clients full access to their order books, and offering order matching outside of traditional exchange hours. ECN's are sometimes also referred to as Alternative Trading Networks
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Functioning of ECNs
To trade with an ECN, one must be a subscriber or have an account with a broker that provides direct access trading. ECN subscribers can enter orders into the ECN via a custom computer terminal or network protocols. The ECN will then match contra-side orders (i.e. a sell-order is "contra-side" to a buy-order with the same price and share count) for execution. The ECN will post unmatched orders on the system for other subscribers to view. Generally, the buyer and seller are anonymous, with the trade execution reports listing the ECN as the party.
Some ECNs may offer additional features to subscribers such as negotiation, reserve size, and pegging, and may have access to the entire ECN book (as opposed to the "top of the book") that contains important real-time market data regarding depth of trading interest.
What electronic communication networks are
The emergence in the late 1990s of electronic trading venues known as "electronic communications networks" (ECNs) made it possible for more individual investors to trade after-hours. In theory, any investor who makes arrangements to access an electronic communications networks can trade in the after-hours marketplace.
To participate in the after-hours trading sessions, you must be a customer of a brokerage firm that either has an ECN of its own or access to one or more ECN's. ECNs include Island, Market XT, Archipelago and Instinet amongst others.
It is important to understand that some ECNs are regulated exchanges, others are sidelines of broker-dealers, and others are unregulated.[1]
ECNs and the stock market
For stock, ECNs exist as a class of SEC-permitted Alternative Trading Systems (ATS). As an ATS, ECNs exclude broker-dealers' internal crossing networks – i.e., systems that match orders in private using prices from a public exchange.
ECN fee structure
ECN's fee structure can be grouped in two basic structures: a classic structure and a credit (or rebate) structure. Both fee structures offer advantages of their own. The classic structure tends to attract liquidity removers while the credit structure appeals to liquidity providers. However since both removers and providers of liquidity are necessary to create a market, ECNs must choose their fee structures carefully.
In a credit structure ECNs make a profit from paying liquidity providers a credit while charging a debit to liquidity removers. Credits range from $0.002 to $0.00295 per share for liquidity providers, and debits from $0.0025 to $0.003 per share for liquidity removers. The fee can be determined by monthly volume provided and removed, or by a fixed structure, depending on the ECN. This structure is common on the NASDAQ market.[2]
In a classic structure, the ECN will charge a small fee to all market participants using their network, both liquidity providers and removers. They also can attract volume to their networks by giving lower prices to large liquidity providers. Fees for ECNs that operate under a classic structure range from $0 to $0.0015, or even higher depending on each ECN. This fee structure is more common in the NYSE, however recently some ECNs have moved their NYSE operations into a credit structure.
ECNs and the currency market
The 1st ECN for internet currency trading was New-York based Matchbook FX formed in 1999. Back then, all the prices were created & supplied by Matchbook FX's traders/users, including banks, within its ECN network. This was quite unique at the time, as it empowered buy-side FX market participants, historically always "price takers", to finally be price makers as well. Today, FX ECNs like Currenex, Bloomberg Tradebook (an affiliate of Bloomberg L.P.), Hotspot FX, FXall & BAXTER Financial Services Ltd with Currency Dealing provide access to an electronic trading network, supplied with streaming quotes from the top tier banks in the world. Their matching engines perform limit checks and match orders, usually in less than 100 milliseconds per order. The matching is quote driven and these are the prices that match against all orders. Spreads are discretionary but in general multibank competition creates 1-2 pip spreads on USD Majors and Euro Crosses. The order book is not a routing system that sends orders to individual market makers. It is a live exchange type book working against the best bid/offer of all quotes. By trading through an ECN, a currency trader generally benefits from greater price transparency, faster processing, increased liquidity and more availability in the marketplace. The banks also reduce their costs as there is less manual effort.
History
One of the key developments in the history of ECNs was the Nasdaq over-the-counter quotation system, created by the National Association of Securities Dealers in February 1971 based on information provided by Joe McCulley to Sperry-Rand in 1968 concerning the structure of an electronic marketplace. A 1964 Securities and Exchange Commission investigation into the opacity of the over the counter markets provided the impetus for creating the NASDAQ. Nasdaq was created following a 1969 American Stock Exchange study estimated that errors in hand-written securities order processing cost brokerage firms approximately $100 million per year. The Nasdaq system automated such order processing and provided brokers with the latest competitive price quotes via a computer terminal. Later, more advanced ECNs would develop from regulatory changes that developed out of a 1994 U.S. Justice Department investigation of possible antitrust violations by Nasdaq itself. This antitrust investigation was sparked by a March 1994 study by two economists, William Christie and Paul Schultz, which noted that Nasdaq bid-ask spreads were larger than was statistically likely, indicating "an implicit agreement among market makers to avoid using odd-eighths in quoting bid and ask prices..." As part of Nasdaq's settlement of these antitrust charges, Nasdaq adopted new order handling rules that integrated ECNs into the Nasdaq system. Shortly after this settlement, the SEC adopted Regulation ATS, which permitted ECNs the option of registering as stock exchanges or else being regulated under a separate set of standards for ECNs.
At that time major ECNs that became active were Instinet and Island (part of Instinet was spun off, merged with Island into INET, and acquired by NASDAQ), Archipelago Exchange (which was acquired by the NYSE) and Brut (now acquired by NASDAQ).
ECNs enjoyed a resurgence after the adoption of SEC Regulation NMS, which required "trade through" protection of orders in the market, regardless of where those orders are placed.
See also
References
External links
- Special Study: Electronic Communication Networks and After-Hours Trading
- ECNs/Alternative Trading Systems
- First Markets Trades Experts Glossary
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