The marriage of electronic trading exchanges Archipelago and Redibook puts heat on



to find its own match.

The merger is the first big salvo in a long-anticipated consolidation among so-called electronic communications networks, the off-exchange forums for stock trading that experienced an explosion of popularity along with online investing in the late 1990s.

Instinet, which used to be a wholly owned unit of



, has already been forced to slash the prices its users pay to trade on the network as rivals Island, Archipelago, Redibook and Brut grab market share. The company's earnings fell 36% to $21 million in the third quarter from a year earlier, while per-share fees on U.S. trades were down 12.8% for the quarter, according to Salomon Smith Barney data.

Investors have taken note. Despite a strong IPO, the stock has declined steadily since its May offering. It plunged another 13% Thursday to $9.70 after the merger announcement and some accompanying downgrades. The stock had peaked at $21.50 shortly after its IPO.

A spokeswoman said Instinet can't comment on any deals "that the company may or may not be interested in developing," and that it will "stay focused on developing its already successful global business."

Eliminating the Middleman

Instinet was the first ECN -- an exchange that matches orders to buy and sell stock without using floor specialists or other intermediaries -- and it is more diversified than its rivals, offering bond trading and deriving 25% of its transaction fees from international trades.

But analysts said that an industry shakeout has been due for some time, and that Instinet might be the next to tie the knot. "I think it's a big threat," says Richard Repetto, Instinet analyst at Putnam Lovell Securities. "The largest competitor before was Island. Now they have another formidable competitor. There's plenty of pricing competition from these other ECNs."

Possible partners include the American Stock Exchange, which reportedly held talks with Instinet early this year, he said. "The Amex is certainly a possibility, as is combining with the other ECNs, or with other alternative trading systems."

Archipelago and Redibook, which are privately held, declined to provide financial details of their deal in a conference call Thursday. The agreement must still be approved by their boards and regulators, but could be completed by early next year.

Executives of the companies said they already have a solid sell-side customer base and will work on gaining market share on the buy side, which tends to pay higher fees per trade.

Archipelago and Redibook had a combined trading volume that accounted for 14.7% of total volume in the third quarter, right behind Instinet's 15.1%. The new partners have gained more market share than any of their rivals in the past two quarters. Instinet's share has fallen to 15.1% from 18% in the first quarter, while Archipelago's share has risen to 5.8% from 4.7% and Redibook's has climbed to 8.9% from 7.2%.

Market share can also be broken down on the basis of internally matched trades, or trades that match buyers and sellers within the exchange. Some analysts prefer the latter, because revenue on matched trades can be twice as high as revenue on unmatched trades. On this basis, Instinet remains in first place, with 11.7%. Island follows with 8.8%, and Archipelago and Redibook combined have 7.6%.

Liquid Assets

Still, increased orders volume at the merged company will make for more liquidity, allowing for more matched trades. Analysts said that will bring prices and costs down. "The combined volume will allow us to stay very competitive on the pricing front," said Gerry Putnam, CEO of Archipelago, who will also act as CEO for the merged company.

Archipelago currently matches about 23% of its trades internally, according to Salomon Smith Barney, routing the rest out to other ECNs. Redibook matches 26% of its trades. The companies said each sends about 10% of its trades to the other.

In the meantime, Nasdaq is struggling to keep ECNs from advancing on its territory. In the third quarter, total ECN trading volumes fell 16%, compared with a 21% drop for the Nasdaq and a 4% decline for the NYSE, according to Salomon. The Nasdaq has responded with two new electronic trading systems: SuperSOES, which started operating in the third quarter, and SuperMontage, which will be launched next year.

SuperSOES provides guaranteed executions on trades, while the system used by the ECNs, SelectNet, does not. The SuperSOES system is also faster than SelectNet, and an updated pricing structure in November may drive its prices below those of Instinet, according to Salomon.

The ECNs currently have an advantage over SuperSOES in that they offer anonymity for market-makers, but the edge won't last for long. The SuperMontage system will also offer anonymity features.