On Wednesday, the New York Stock Exchange announced plans to merge with Archipelago, which operates a fully electronic stock exchange called ArcaEX. The move is expected to give the NYSE a competitive advantage over its leading stock market rivals, Nasdaq and Instinet. But neither Nasdaq nor Instinet is a registered national stock exchange. What’s the difference between stock markets and stock exchanges?
The Securities and Exchange Commission lists seven registered stock exchanges. These include the NYSE and smaller regional markets like the Boston Stock Exchange and the Philadelphia Stock Exchange, the country’s oldest. All of the exchanges function as stock markets—they provide a way for buyers and sellers to set prices and trade stocks.
Exchanges, which must be registered with the SEC, have the authority to list stocks for trading—and to charge companies a listing fee for the service. (Nasdaq is not registered, but it can function like an exchange because it is run by a registered securities association.) They can also sell memberships that allow brokers access to the market. The NYSE uses a floor-based auction system to execute some of its trades, which means that intermediaries on the bustling floor determine the price of the stocks. Exchanges can also use an automated system to match up buyers and sellers. In the past 10 years or so, automated markets have gained popularity because of their speed and efficiency and because they eliminate the possibility of corruption among traders on the floor.
If you’re registered with the SEC as a broker-dealer, you are allowed to set up an automated stock market that sells exchange-listed stocks, without actually starting an exchange. Instinet operates one of these automated stock markets, which are called ECNs, or “Electronic Communications Networks.”
How do exchanges and ECNs differ? Exchanges can list stocks, but both exchanges and ECNs can orchestrate transactions, collect transaction fees, and produce and sell market data. Exchanges govern themselves, to some degree, with their own regulatory arms; ECNs are regulated both by the SEC and by a national securities association (to which any registered broker-dealer is required to belong).
To start an ECN, a broker-dealer needs to devise a set of rules for matching up buyers and sellers. For example, the market might rely on a price-time system through which sellers are matched with buyers offering the best deal on a first-come, first-served basis. These rules are then programmed into a computer system that controls the trading.
Both Nasdaq and Instinet have made efforts to broaden their businesses and register as exchanges. To start an exchange, a company must demonstrate to the SEC that it is capable of following all of the rules in the Securities Exchange Act and that it can police itself adequately.
Explainer thanks Kumar Venkataraman of Southern Methodist University.