NEW YORK -- William H. Donaldson, the new chief executive of the New York Stock Exchange, outlined a bleak future for the nation's capital markets yesterday, warning that increasingly "fractionalized" trading could lead to poorer supervision and lower values for stocks.
Trades once done for retail investors on the floor of the New York Stock Exchange are increasingly being consummated in-house by major brokerage firms. Major institutions also are starting to bypass the exchange floor by using electronic systems or overseas markets, Mr. Donaldson said.
These trading methods don't require as much disclosure and may be cheaper per transaction, but they carry a cost for the overall market, Mr. Donaldson said. The result is a "Balkanized" structure with less assurance of proper pricing. This, in turn, impedes transactions and adds uncertainty -- byproducts that will ultimately lessen the price investors are willing to pay for domestic securities, he said.
The 199-year-old New York Stock Exchange uses an auction market, with all transactions in a company's shares supervised by an individual at a single trading post and reported over an electronic message board commonly referred to as "the tape."
While the exchange's interlocking trading floors on the corner of Wall and Broad streets in Lower Manhattan remain the single most concentrated capital market in the country, its share of the business has been steadily declining in recent decades. Last year, for the first time, it accounted for less than half of the average daily volume of shares traded. Mr. Donaldson's comments were a striking admission of vulnerability by the head of an institution once known for its power and arrogance.
Direct competitors include the similarly structured American Stock Exchange, aggressive regional markets that mimic movements on the New York Exchange and an electronic wire run by Reuters known as Instinet. The most powerful of allis the National Association of Securities Dealers Automated Quotations, an electronic system spread throughout the country and driven by computers located in Maryland and Connecticut.
The New York Stock Exchange also indirectly faces increasingly stiff competition from the Chicago commodities markets, which during the 1980s developed a booming business trading futures and options based on market indexes such as the Standard FFTC Poor's 500. Since the money invested in these futures and options never flows to the underlying companies, Mr. Donaldson said, they ignore "the main goal of the market" -- to channel capital to business.
To preserve its franchise, Mr. Donaldson said, the exchange has taken steps to control costs by cutting overhead. It also intends to aggressively encourage the return of small investors, now "by and large frightened out of the market."
Additionally, Mr. Donaldson said, the exchange is eager to begin trading shares in the largest foreign companies, which currently are discouraged from listing on the exchange because of Securities and Exchange Commission rules requiring conformance with U.S. accounting and disclosure rules.
"It will be a long time before international accounting standards [are established]. We can't agree on our own," Mr. Donaldson said. But "we have to find a way to allow at least the largest of the foreign companies to list. Whether we do it or not, these securities will be bought and sold."
The exchange is also becoming at least partially electronic itself. Mr. Donaldson said that during the past decade it has invested $600 million to update its electronic trading systems and would continue to investigate automation. But he asserted that its current method, with a person on the floor of the exchange to orchestrate trading in a stock, remains essential. "I don't see a machine being able to do it all," he said.