For Citi, an Exchange of Its Own?

It plans to develop a trading system, which won't compete with the Big Board and Nasdaq right away but could provide a lower-cost alternative

If the New York Stock Exchange and Nasdaq hope to raise prices for stock traders this year, Citigroup (C ) may have an antidote. One of the nation's biggest stock traders, Citi is backing alternative trading systems that it expects will offer cheaper and faster trading venues. Now it plans to build up its own.

Citi's Jan. 18 announcement that it will develop a trading platform based on the OnTrade electronic communications network (ECN) that it acquired last week is the bank's latest and biggest shot across the bow of the two giant markets, experts say. Citi last year took 10% stakes in both the Boston and Philadelphia exchanges, joining with other big trading firms in investing in those potential alternatives. Earlier, in 2004, it acquired the Lava order-routing system that beefs up its electronic trading prowess.

"We're just putting the pieces together that we think will not only lower our transaction costs but also give us the ability to enhance our revenues and offer our clients the best execution and flexibility," Citigroup Managing Director C. Thomas Richardson told BusinessWeek Online.

BEST PRICE WINS. All the moves come in advance of so-called Reg NMS, a new rule from the U.S. Securities & Exchange Commission set to go into effect later this year. The rule, part of a longstanding national market system initiative, will require Wall Street to route orders for stock trades to markets that offer the best prices.

If the NYSE or Nasdaq offer the best quotes, stock trades will go to them. But if better prices can be found in alternative markets, especially those that boast of lower fees, they can capture the business.

By building up its electronic trading power, Citi's managers plan to be ready to comply with NMS as well as to strengthen bulwarks against the big exchanges raising fees. "Like most of the major players, they are developing either investments or platforms as a hedge to the two major exchanges," says Sandler O'Neill & Partners analyst Richard H. Repetto.

Citi hasn't spelled out what exactly it plans to do with the OnTrade system, which was one of the last freestanding ECNs. While officials at the bank say they don't want to build a full-fledged alternative exchange that would compete across the board with either the NYSE or Nasdaq, they do want to have lower-cost alternatives in case prices rise too sharply at the big two.

"GOOD COUNTERBALANCE." Market watchers fear that both bigger exchanges could gouge consumers without checks on their power, as the markets shrink into a duopoly. Both of the bigger outfits are bulking up by acquiring ECN rivals. The NYSE has snapped up the Archipelago ECN (see BW Online, 12/7/05, "NYSE-Arca: Think Global, Fight Local"), while Nasdaq has beefed itself up with its purchase last year of Instinet's ECN, called INET.

Already, both of the bigger markets have imposed modest price hikes on some customers. The NYSE targeted floor traders, asking them to pay a $5,000 annual fee to use handheld trading devices on the floor of the exchange, for instance.

Last year, the NYSE floated the idea of broader hikes, but it hasn't implemented them. A spokesman for the exchange declined to comment on the Citi move but says the thing customers care most about is having a market that offers "the best prices and highest quality transactions."

So far customers haven't balked at the repricing arrangements, but they aren't expecting more costly run-ups either. "The industry is looking for more competition," says Seth Merrin, CEO of Liquidnet, an alternative market for big institutional traders. "This is a good counterbalance."

SAFETY NET. Since it accounts for stock trades each day in the hundreds of millions of shares, Citi could face higher costs if the markets impose even slight increases on transaction fees. But by having alternatives, the bank is betting it won't face such hikes.

Citi officials decline to say how much they intend to spend to build up their alternative system beyond promising to develop a system powerful enough to attract traders to a "robust liquidity pool."

More likely, Citi is putting the exchanges on notice. If they gouge, they'll find themselves having to fight other players for every fraction of a penny. For investors, the new moves could add up to insurance that they'll be getting the best deals possible.

READER COMMENTS

Weber is BusinessWeek's Chicago bureau chief

BW MALL SPONSORED LINKS

Mutual Funds at Fidelity Benefit from years of mutual fund management experience.
High interest checking, No ATM fees! 2.02 APY, FDIC insured, mobile banking and no fee bill pay. Incredible!
Master HR Compentencies Online w/ Villanova U. Earn a HR Master Certificate & Gain the Skills to Execute Effective Employee Relations - Enroll Now!
Your Customers Speak Email: Do You? You Already Have What You Need to Maximize ROI: Your Current Customers.
The Business of Entertainment Learn Management, Artist Relations, Producing and More with an Online Degree.

Buy a link now!

Get BusinessWeek directly on your desktop with our RSS feeds. XML

Add BusinessWeek news to your Web site with our headline feed.

Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video.

To subscribe online to BusinessWeek magazine, please click here.

Learn more, go to the BusinessWeekOnline home page