It's crunch time for the specialist firms that once were the powerhouses that drove trading on the New York Stock Exchange ( NYX). The Big Board is putting the finishing touches on its so-called hybrid market, which combines electronic trading with old-fashioned floor trading. Beginning today, 3,600 stocks and other securities listed on the NYSE can now be traded either electronically or through the aid of a specialist -- a floor-based trader. That's great news for investors because the hybrid market will no doubt lead to lower trading-related costs. But the full rollout of the hybrid market, which already is crimping profit margins for the specialists, could push Big Board trading firms such as LaBranche ( LAB) and Van der Moolen ( VDM) over the edge. On Tuesday, Dutch-based Van der Moolen said it was laying off 30% of the employees at its U.S. specialist division. The firm blamed the job cuts on the hybrid market's cutting into its market share. LaBranche earlier announced its own round of equally deep job cuts. Other firms such as Bank of America ( BAC) and Lehman ( LEH) have also made severe cuts in their specialist businesses. And things are likely to only get worse for the specialists now that the hybrid market is fast making in-person market makers obsolete. The final leg of the NYSE's hybrid platform intensifies the need for a stand-alone specialist firm like LaBranche to either figure out another business model or toss in the towel.
The NYSE, which had been an open outcry market, has been working feverishly to bring trading on the exchange into the electronic era, particularly as the Nasdaq Stock Market ( NDAQ), smaller regional exchanges, and electronic communication networks such as BATS Trading take center stage in the trading arena. Its hybrid market now may hasten the NYSE's famous trading floor into the history books. In fact, in advance of the full hybrid rollout, the exchange has been shuttering certain trading floors in an effort to contain costs. Meanwhile, Wall Street firms have been laying off floor traders too. The NYSE insists that the specialist will not die. Big Board CEO John Thain, the mastermind behind the hybrid market concept, keeps saying specialists are still needed to provide liquidity for less-liquid stocks, as well as for processing some large block trades. The Big Board is trying to provide some monetary relief for specialist firms by creating a revenue-sharing program and eliminating some monthly transaction fee caps. But the revenue-sharing system and Thain's promises may be more an attempt to mollify the specialists than anything else. LaBranche, for instance, owns quite a few NYSE shares. The truth is that the outlook is dire for LaBranche and its specialist peers. Lately, LaBranche has been mum on its plans. The firm has yet to say when it will report fourth-quarter earnings, which could be a sign that it is preparing for a large strategic change, some say. It did not respond to requests for an interview.
James Angel, an associate professor of finance at Georgetown University, says specialist firms "have to evolve or die.'' He says specialists need to find a new business model, just like the market makers on other exchanges. "Many of them left the business, but the ones that survived have evolved into high-tech liquidity providers, becoming more computerized, faster, more nimble and also branching out into other products as well," he says. To strengthen its U.S. business, Van der Moolen has made investments in the equity platforms of the Chicago Board Options Exchange and International Securities Exchange ( ISE). LaBranche is trying to adapt by having most of its nearly 600 stocks listed on hybrid, says Richard Herr, an analyst at Keefe Bruyette & Woods. That means LaBranche is equipped to execute those trades electronically, not just with human traders. It also provides specialist services for options, futures and exchange-traded funds on several other exchanges. Herr says that LaBranche "is trying to deal with how things are changing and right-size the company." But he believes the firm, whose shares he rates underperform, will survive. "A lot will depend on how what the large brokerage houses do and how much trading they'll continue to do on the floor," he says. Big Wall Street firms have "cut back, but they haven't cut to zero," Herr says. "As long as the big brokers keep floor brokers, the specialists are going to have to keep post."