Discussion

In response to Lee's prediction that demutualized exchanges will require more regulation, Jeff Smith noted that Nasdaq has separated its regulator, the National Association of Securities Dealers, from the exchange without demutualization, while the New York Stock Exchange has resisted that sort of separation. Lee replied that because there will continue to be competing trading systems, there might be separate regulators. He also noted that, although most of the regulatory debate about demutualization has centered on how one can appropriately continue with self-regulation, self-regulation is not a great deal more problematic under the demutualized structure than it is under the mutual structure.

Hans Stoll disagreed with Lee's assertion that linked exchanges are doomed to failure. Stoll agreed that the kind of linkages that Lee talked about—where the floors of various exchanges are linked under some operating agreement like ITS to funnel order flow from one exchange to another—are old-fashioned and have not worked well. However, he felt that an "upstairs linkage" would work—that is, a kind of virtual market where the links are in the computer of the broker who represents the stock, and orders are routed to the trading system that best suits the customer's needs. In this kind of market structure, order-routing firms might also distill screens into a virtual book and send orders automatically or through some order-routing process, based on variety of speed and certainty of execution to the best market.

Lee countered by stating that, in his paper, he was referring not only to linkages between trading floors but also to linkages in other functions that exchanges perform: marketing, listing, order routing, information disseminating, clearing, and so forth. However, he noted that very few of the proposed linkages have been implemented, and of those that have, even fewer have succeeded. As for virtual linkages, Lee responded that private sector solutions are working fine in this regard, giving the examples of Virt-X and LSE linking information between screens. Lee believed it unnecessary to mandate linkages between trading systems or exchanges.

One participant distinguished between the two types of integration of markets: government-imposed and competitively imposed. He commented that it is appropriate for the Securities and Exchange Commission to provide ease of entry for new trading systems. Although most of them will fail, like Optimark and the Arizona Stock Exchange, if a better system does appear it will dominate or be incorporated. He also noted that the corporate bond market in the United States is highly fragmented. It is not in the interest of dealers to publish last-trade prices, as the market would become integrated quickly if they did. The Securities and Exchange Commission has a real role in providing information about what is happening in different marketplaces, and that information leads to integration.

Cally Jordan wanted to know the prognosis for linkages, mergers, and acquisitions of exchanges and for the development of securities markets more generally in smaller countries. Lee responded by pointing to the section of his paper where he mentioned the "trilemma" that small exchanges face. That is, small exchanges can proceed autonomously, try to set up regional linkages, or explicitly enter into regional mergers, like those seen in West Africa. Lee suggested that it is now more widely accepted that interest in the shares of such local companies is dominated for the most part by local residents; therefore, such small exchanges can exist as long as they keep costs low. Lee gave the example of some Internet exchanges that need a very small order flow to remain in business.

Richard Herring was intrigued by the notion that there are enormous centralizing tendencies for clearing and settlement. He wondered whether an increasing amount of regulation would be focused on clearing and settlement simply because it was easiest to regulate these activities. In response, Lee emphasized that clearing and settlement are two separate activities. He believed that clearing is very much a natural monopoly, and noted that the European Commission is...