A brief history of ECNs
What comes to your mind when someone mentions ‘ECNs’? Stock exchanges? NYSE and NASDAQ? Prior to reading Scott Patterson’s Dark Pools, I knew very little about Alternate Trading Systems (ATS) and how famous public exchanges such as NYSE and NASDAQ came to be. This post is not meant to be a detailed history of (US) trading venues but instead to provide you with a brief overview of different ECNs that exist or existed and how they led to today’s behemoth trading venues.
What are ECNs?
ECN stands for electronic communication network. An ECN is an automated system where client orders are matched. ECNs eliminate the need to interact with a middleman, such as an exchange market maker, to buy or sell securities. ECNs earn money by charging users a fee for each transaction. While public exchanges have fixed hours dedicated to trading, ECNs are usually open 24 hours and hence, facilitate after-hours trading.
Instinet – the first ECN
Instinet, which stood for Institutional Networks, was the first ECN. It was founded by Jerome M. Pustilnik and Herbert R. Behrens in 1967 to compete with NYSE. Instinet linked big institutional investors like banks, mutual funds, and insurance companies so they could trade without any middleman. Instinet had a slow start in the 1970s but started to pick up in the 1980s. While markets around the world crashed on Black Monday, October 29, 1987, and most brokers and market makers stopped taking calls, Instinet continued to operate. Reuters owned a majority portion of Instinet and in May 1987, it acquired Instinet complete.
Reuters took Instinet public in 2001. However, as competition increased, Instinet continued to lose its market share and ended up merging with Island in 2002. In 2005, NASDAQ bought the merged product. The ECN was then sold to a private equity firm, Silver Lake Partners, and was later acquired by Nomura in 2007.
Josh Levine, a brilliant programmer, wanted to make the markets more transparent and fast and he did so by creating an ECN called, The Island. Josh Levine founded The Island in 1996 with Jeff Citron. The Island was a state-of-the-art system at the time and provided its users with a data feed called ITCH. NASDAQ and NYSE refused to create their own ECNs (electronic communication networks) and simply watched Island steal their market share.
As mentioned earlier, The Island, would go on to merge with Instinet in 2001 and then be acquired by NASDAQ later in 2005. Island’s data feed, ITCH, is still used at NASDAQ and is called Nasdaq TotalView-ITCH.
As Island was growing, Jerry Putnam created an ECN called Archipelago in 1997. While Island only matched orders internally, Archipelago was able to link multiple ECNs together. Its name, Archipelago, was a play on Island’s name as an archipelago is a chain of islands.
Archipelago was the first ECN to be approved by SEC to open a national stock exchange. In 2000, Archipelago partnered with Pacific Exchange to create Archipelago Securities Exchange (ArcaEx). ArcaEx was gaining a lot of popularity and was usually preferred by traders for trading NYSE stock electronically instead of NYSE’s open outcry method. In 2005, ArcaEx was acquired by NYSE. Interestingly, two most popular ECNS, Instinet and Archipelago, were both acquired by NASDAQ and NYSE, respectively, within a week of each other.
Bloomberg TradeBook, BRUT and REDIBOOK
As Instinet and Arca were starting up, few other ECNs were also entering the market. Bloomberg created its own ECN called TradeBook in 1996. REDIBOOK was launched in 1997 by Spears, Leeds and Kellog and in 1998, BRUT was launched by Automated Securities Clearance.
In 1998, another ECN was launched called Attain. It was later acquired by Knights Capital Group (remember them?) in 2005. Two years later, in 2007, a new ECN was spun off by the name Direct Edge. Citadel and Goldman Sachs also owned Direct Edge along with Knights Capital Group. In 2008, International Securities Exchange (ISE) also acquired a major stake in the company.
In 2010, Direct Edge was granted permission by SEC to transition into a national securities exchange. In 2014, Direct Edge merged with BATS to form BATS Global Markets.
In 2007, Instinet created Chi-X Europe which was later bought by BATS in 2011. Currently, there are several Chi-X exchanges around the world such as Chi-X Australia and Chi-X Japan.
Better Alternative Trading Systems (BATS)
Dave Cummings created BATS shortly after Instinet and Arca were acquired by NASDAQ and NYSE, respectively, in 2006. Dave wanted a platform which was not owned by the two big exchanges and could provide its clients fair prices.
BATS acquired Chi-X Europe in 2011 and merged with Direct Edge in 2014. BATS was just recently acquired by Chicago Board of Exchange (CBOE) for $3.2bn in 2016.
After reading about all these mergers and acquisitions, your head must be hurting a little. Here is a timeline to make it easier for you to understand:
1967: Instinet launched
1996: Island and TradeBook launched
1997: REDIBOOK launched
1998: BRUT and Attain launched
2001: Island merges with Instinet
2005: NYSE acquires Arca and NASDAQ acquires Instinet, Attain is acquired by Knights Capital Group
2006: BATS launched
2007: Attain is relaunched as Direct Edge, Instinet is acquired by Nomura, Instinet launches Chi-X Europe
2011: BATS acquires Chi-X Europe
2014: Direct Edge and BATS merge to form BATS Global Markets
2016: CBOE acquires BATS Global Markets
I hope you found this post informational and interesting! For those who noticed that many ECNs mentioned in this post started in the late 1990s, there is a reason behind that – SEC’s Order Handling Rules. I will cover that in another post later.