Electronic communication network
Encyclopedia
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 exchange
s. The primary products that are traded on ECNs are stock
s and currencies
. The first ECN, Instinet
, was created in 1969. 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. ECNs are sometimes also referred to as Alternative Trading Networks or Alternative Trading Systems
.
. 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.
ECNs are generally facilitated by electronic negotiation, a type of communication between agents that allows cooperative and competitive sharing of information to determine a proper price.
type. As of 2005, most e-business negotiation systems can only support price negotiations. Traditional negotiations typically include discussion of other attributes of a deal, such as delivery terms or payment conditions. This one-dimensional approach is one of the reasons why electronic markets struggle for acceptance. Multiattributive and combinatorial auction
mechanisms are emerging to allow further types of negotiation.
Support for complex multi-attribute negotiations is a critical success factor for the next generation of electronic markets and, more generally, for all types of electronic exchanges. This is what the second type of Electronic negotiation, namely Negotiation Support, addresses. While auctions are essentially mechanisms, bargaining is often the only choice in complex cases or those cases where no choice of partners is given. Bargaining is a hard, error-prone, ambiguous task often performed under time pressure. Information technology
has some potential to facilitate negotiation processes which is analyzed in research projects/prototypes such as INSPIRE, Negoisst or WebNS.
The third type of negotiation is automated argumentation, where agents exchange not only values, but also arguments for their offers/counter-offers. This requires agents to be able to reason about the mental states of other market participants.
s. If negotiations occur frequently, possibly on a minute per minute basis in order to schedule network capacity, or negotiation topics can be clearly defined it may be desirable to automate this coordination effort.
Automated negotiation is a key form of interaction in complex systems composed of autonomous agents. Negotiation is a process of making offers and counteroffers, with the aim of finding an acceptable agreement. During negotiation, each offer is based on its own utility and expectation of what other agents do. This means that a multi criteria decision making is need to be taken for each offer.
(ATS). As an ATS, ECNs exclude broker-dealers' internal crossing network
s – i.e., systems that match orders in private using prices from a public exchange.
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.. Traders commonly quote the fees in millicents or mils (e.g. $0.00295 is 29.5 mils).
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.
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, 360T, 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 bank
s also reduce their costs as there is less manual effort.
's being filed against NASDAQ. As part of NASDAQ's settlement of the 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.
Stock exchange
A stock exchange is an entity that provides services for stock brokers and traders to trade stocks, bonds, and other securities. Stock exchanges also provide facilities for issue and redemption of securities and other financial instruments, and capital events including the payment of income and...
s. The primary products that are traded on ECNs are stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
s and currencies
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
. The first ECN, Instinet
Instinet
Instinet is an institutional, agency-only broker. As such, it executes trades for roughly 1,500 “buyside” clients such as asset management firms, hedge funds, insurance companies, mutual funds and pension funds...
, was created in 1969. 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. ECNs are sometimes also referred to as Alternative Trading Networks or Alternative Trading Systems
Alternative Trading Systems
Alternative Trading Systems , are United States Securities and Exchange Commission approved non-exchange trading venues specifically designed to match buyers and sellers to find counterparties for transactions, instead of trading large blocks of shares on the normal exchange, a practice that can...
.
Function
To trade with an ECN, one must be a subscriber or have an account with a broker that provides direct access tradingDirect access trading
Direct access trading is a technology which allows stock traders to trade directly with market makers or specialists, rather than trading through stock brokers....
. ECN subscribers can enter orders
Order (exchange)
An order in a market such as a stock market, bond market, commodity market or financial derivative market is an instruction from customers to brokers to buy or sell on the exchange.These instructions can be simple or complicated...
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.
ECNs are generally facilitated by electronic negotiation, a type of communication between agents that allows cooperative and competitive sharing of information to determine a proper price.
Negotiation types
The most common paradigm is the electronic auctionAuction
An auction is a process of buying and selling goods or services by offering them up for bid, taking bids, and then selling the item to the highest bidder...
type. As of 2005, most e-business negotiation systems can only support price negotiations. Traditional negotiations typically include discussion of other attributes of a deal, such as delivery terms or payment conditions. This one-dimensional approach is one of the reasons why electronic markets struggle for acceptance. Multiattributive and combinatorial auction
Auction
An auction is a process of buying and selling goods or services by offering them up for bid, taking bids, and then selling the item to the highest bidder...
mechanisms are emerging to allow further types of negotiation.
Support for complex multi-attribute negotiations is a critical success factor for the next generation of electronic markets and, more generally, for all types of electronic exchanges. This is what the second type of Electronic negotiation, namely Negotiation Support, addresses. While auctions are essentially mechanisms, bargaining is often the only choice in complex cases or those cases where no choice of partners is given. Bargaining is a hard, error-prone, ambiguous task often performed under time pressure. Information technology
Information technology
Information technology is the acquisition, processing, storage and dissemination of vocal, pictorial, textual and numerical information by a microelectronics-based combination of computing and telecommunications...
has some potential to facilitate negotiation processes which is analyzed in research projects/prototypes such as INSPIRE, Negoisst or WebNS.
The third type of negotiation is automated argumentation, where agents exchange not only values, but also arguments for their offers/counter-offers. This requires agents to be able to reason about the mental states of other market participants.
Technologies
One research area that has paid particular attention to modeling automated negotiations is that of autonomous agentAutonomous agent
An autonomous agent is an intelligent agent operating on an owner's behalf but without any interference of that ownership entity. An intelligent agent, however appears according to a multiply cited statement in a no longer accessible IBM white paper as follows:Intelligent agents are software...
s. If negotiations occur frequently, possibly on a minute per minute basis in order to schedule network capacity, or negotiation topics can be clearly defined it may be desirable to automate this coordination effort.
Automated negotiation is a key form of interaction in complex systems composed of autonomous agents. Negotiation is a process of making offers and counteroffers, with the aim of finding an acceptable agreement. During negotiation, each offer is based on its own utility and expectation of what other agents do. This means that a multi criteria decision making is need to be taken for each offer.
In the stock market
For stock, ECNs exist as a class of SEC-permitted Alternative Trading SystemsAlternative Trading Systems
Alternative Trading Systems , are United States Securities and Exchange Commission approved non-exchange trading venues specifically designed to match buyers and sellers to find counterparties for transactions, instead of trading large blocks of shares on the normal exchange, a practice that can...
(ATS). As an ATS, ECNs exclude broker-dealers' internal crossing network
Crossing network
A crossing network is an ATS that matches buy and sell orders electronically for execution without first routing the order to an exchange or other displayed market, such as an ECN , which displays a public quote...
s – i.e., systems that match orders in private using prices from a public exchange.
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
NASDAQ
The NASDAQ Stock Market, also known as the NASDAQ, is an American stock exchange. "NASDAQ" originally stood for "National Association of Securities Dealers Automated Quotations". It is the second-largest stock exchange by market capitalization in the world, after the New York Stock Exchange. As of...
market.. Traders commonly quote the fees in millicents or mils (e.g. $0.00295 is 29.5 mils).
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
New York Stock Exchange
The New York Stock Exchange is a stock exchange located at 11 Wall Street in Lower Manhattan, New York City, USA. It is by far the world's largest stock exchange by market capitalization of its listed companies at 13.39 trillion as of Dec 2010...
, however recently some ECNs have moved their NYSE operations into a credit structure.
In the currency market
The 1st ECN for internet currency trading was New-York based Matchbook FXMatchbook FX
Matchbook FX was an internet-based Electronic communication network for trading currency online in the FX or Foreign exchange market.-History:...
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
Currenex
Currenex, Inc. is a New York based company that provides a platform for the electronic foreign exchange market providers. It focuses on connecting buy and sell side forex traders using the FIX protocol and other application programming interfaces...
, Bloomberg Tradebook (an affiliate of Bloomberg L.P.
Bloomberg L.P.
Bloomberg L.P. is an American privately held financial software, media, and data company. Bloomberg makes up one third of the $16 billion global financial data market with estimated revenue of $6.9 billion. Bloomberg L.P...
), Hotspot FX, 360T, 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
Transparency (humanities)
Transparency, as used in science, engineering, business, the humanities and in a social context more generally, implies openness, communication, and accountability. Transparency is operating in such a way that it is easy for others to see what actions are performed...
, faster processing, increased liquidity
Market liquidity
In business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value...
and more availability in the marketplace. The bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
s 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. NASDAQ was created following a 1969 American Stock Exchange study which estimated that errors in the processing of hand-written securities orders 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. In March 1994, a study by two economists, William Christie and Paul Schultz, noted that NASDAQ bid-ask spreads were larger than was statistically likely, indicating "We are unable to envision any scenario in which 40 to 60 dealers who are competing for order flow would simultaneously and consistently avoid using odd-eighth quotes without an implicit agreement to post quotes only on the even price fractions. However, our data do not provide direct evidence of tacit collusion among NASDAQ market makers." These results led to an antitrust lawsuitNasdaq Market Makers Antitrust Litigation
Nasdaq Market-Makers Antitrust Litigation - class-action lawsuit initiated in 1996 alleging collusion amongst Wall Street traders. The class action alleged that NASDAQ market-makers set and maintained wide spreads pursuant to an industry-wide conspiracy...
's being filed against NASDAQ. As part of NASDAQ's settlement of the antitrust charges, NASDAQ adopted new order handling rules that integrated ECNs into the NASDAQ system. Shortly after this settlement, the SEC adopted Regulation ATS
Alternative Trading Systems
Alternative Trading Systems , are United States Securities and Exchange Commission approved non-exchange trading venues specifically designed to match buyers and sellers to find counterparties for transactions, instead of trading large blocks of shares on the normal exchange, a practice that can...
, 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
Instinet
Instinet is an institutional, agency-only broker. As such, it executes trades for roughly 1,500 “buyside” clients such as asset management firms, hedge funds, insurance companies, mutual funds and pension funds...
and Island
Island Exchange
Island Exchange, abbreviated ISLD, was an electronic securities exchange, now part of NASDAQ. Island changed its name to Inet ATS, Inc. effective November 17, 2003....
(part of Instinet was spun off, merged with Island into Inet
Inet
Inet, previously known as Island ECN, was an electronic trading platform. It was renamed to Inet after the Island Exchange was merged with Instinet in 2002. It was acquired by NASDAQ in 2005....
, and acquired by NASDAQ
NASDAQ
The NASDAQ Stock Market, also known as the NASDAQ, is an American stock exchange. "NASDAQ" originally stood for "National Association of Securities Dealers Automated Quotations". It is the second-largest stock exchange by market capitalization in the world, after the New York Stock Exchange. As of...
), Archipelago Exchange (which was acquired by the NYSE) and Brut
Brut
-Literature:* Roman de Brut, a verse chronicle in Anglo-Norman by Wace* Layamon's Brut, an English chronicle by Layamon based on Wace* Brut y Tywysogion , a Welsh mediaeval chronicle...
(now acquired by NASDAQ).
ECNs enjoyed a resurgence after the adoption of SEC Regulation NMS
Regulation NMS
Regulation NMS is a regulation promulgated and described by the United States Securities and Exchange Commission as "a series of initiatives designed to modernize and strengthen the national market system for equity securities." It was established in 2007...
, which required "trade through" protection of orders in the market, regardless of where those orders are placed.
See also
- Extended hours tradingExtended hours tradingAfter-hours trading is stock trading that occurs after the traditional trading hours of the major exchanges, such as the New York Stock Exchange and the Nasdaq Stock Market. Since 1985, the regular trading hours in America have been from 9:30 a.m. to 4:00 p.m...
- NASDAQNASDAQThe NASDAQ Stock Market, also known as the NASDAQ, is an American stock exchange. "NASDAQ" originally stood for "National Association of Securities Dealers Automated Quotations". It is the second-largest stock exchange by market capitalization in the world, after the New York Stock Exchange. As of...
- American Stock ExchangeAmerican Stock ExchangeNYSE Amex Equities, formerly known as the American Stock Exchange is an American stock exchange situated in New York. AMEX was a mutual organization, owned by its members. Until 1953, it was known as the New York Curb Exchange. On January 17, 2008, NYSE Euronext announced it would acquire the...
- NYSE ArcaNYSE ArcaNYSE Arca, previously known as ArcaEx, an abbreviation of Archipelago Exchange, is a securities exchange on which both stocks and options are traded...
- InetInetInet, previously known as Island ECN, was an electronic trading platform. It was renamed to Inet after the Island Exchange was merged with Instinet in 2002. It was acquired by NASDAQ in 2005....
- Island ExchangeIsland ExchangeIsland Exchange, abbreviated ISLD, was an electronic securities exchange, now part of NASDAQ. Island changed its name to Inet ATS, Inc. effective November 17, 2003....
- cTrader
External links
- Special Study: Electronic Communication Networks and After-Hours Trading
- ECNs/Alternative Trading Systems
- First Markets Trades Experts Glossary