Island ECN has played a key role in redefining how stocks and other securities are traded. Island is an electronic marketplace that enables market professionals to display limit orders for stocks and other securities, directly matching buyers and sellers, and in doing so eliminating many of the traditional stock market middlemen and their fees. Thousands of market participants enter over 2 billion shares into Island every trading day, averaging over 400 million shares traded on a daily basis.
As an Electronic Communication Network (ECN), Island is part of the NASDAQ. The NASDAQ functions as a collection of marketplaces, offering a quotation service, whch lists the best price for the stocks traded, and connectivity services that enable participants to interact with each other. The NASDAQ, however, does not offer trading services. Therefore market professionals must ensure that their orders for NASDAQ securities are posted in a marketplace that offers best liquidity, that is, the best chances of getting an execution quickly at low-cost. Island ECN proved that it could meet all these needs. In 2001 Island was the second largest ECN, after Instinet Inc.
HOW ISLAND WORKS
Suppose an investor decides to sell 100 shares of a particular stock for $20.00 a share. Island's system is scanned instantaneously for unfilled orders for that stock at $20.00. If a match is found, the order is executed immediately. If there is no match, the order is displayed on Island's order book until a matching order to buy is entered or the original order is cancelled. Island accepts orders from market makers, agency brokers, retail brokers, day-trading firms, proprietary trading firms, and institutional firms. Trades on Island can only flow through one of its seven hundred-plus client brokers; individual investors cannot use Island's services directly. During the 1990s, Island concentrated on serving retail investors; in 2001 it began to refocus its efforts on business-to-business trading.
Virtually all orders can be viewed, in real-time and without charge, on Island's Web site through the BookViewer, an online representation of Island's limit order book. The best-priced order on Island for a NASDAQ security is also represented on the NASDAQ Level II screen, where the best bids and offers of all market participants are posted. If an order on Island is the best price from among all the different market participants, it will also be featured on the NBBO, the National Best Bid/Offer display. Island was the first marketplace to make its order information available on such a scale. The BookViewer does not track the activity of the entire NASDAQ by any means. However, because Island accounts for such a high percentage of NASDAQ trading—about 16 percent in 2001—its online order book can offer a fairly accurate picture of NASDAQ activity. Island also provides investors with an online toolbox that includes a list of the 20 most active issues on Island; a time and sales report generator that shows what time trades took place, and at what price; and an instant alert feature that notifies investors when a stock hits a predefined price or level of volume.
Island sees tremendous activity every trading day—during the first two quarters of 2001 trading activity on Island accounted for approximately one in every 6 trades on NASDAQ. Trading at Island ECN grew by leaps and bounds in the 2000s. Between 1999 and 2000 volume doubled to 53.7 billion shares; it increased by 80 percent in 2001. Its base of client subscribers also grew rapidly, from about 150 in late 1998, to 400 at the beginning of 2001. By the end of that year the number had passed 700.
THE EMERGENCE OF ISLAND
The groundwork for Island ECN was laid by Joshua Levine, who in the mid-1990s wrote the software that would become the basis for its electronic trading system. Levine's system grew out of NASDAQ's SOES—small order execution system—which was introduced after the 1987 stock market crash. SOES automatically matched trades of 1,000 shares or less, making it possible for investors to deal with one another directly, without the intervention of the traditional middlemen.
Island was founded in 1997 by Jeff Citron and Levine with funding from Datek Online Holdings Corporation. Island was an immediate hit, its popularity driven in part by the day trading fad of the late 1990s. The effects were felt throughout the stock world. Competing ECNs were soon opening their virtual doors, and NYSE and NASDAQ were compelled to look for ways to simplify their business in order to meet the challenge. Levine himself fueled the competition with his outspoken criticisms of NYSE and NASDAQ as anticompetitive monopolies. Thanks to Levine's efforts, the NYSE eventually repealed its rule prohibiting its members from trading substantial amounts of NYSE-listed stock off the trading floor. The repeal made it possible for Island to begin trading in stock listed on the New York Stock Exchange.
Levine stepped aside in 1998 and was replaced as Island's President and CEO by Matthew Andresen, who was also fired by a passion to change the way securities were traded. Under Andresen, in June 1999 Island applied to the SEC to become the nation's first for-profit exchange, enabling it compete head-to-head with NYSE and NASDAQ for orders. Some critics speculated market status would impose on Island the crippling costs of instituting and enforcing a complex set of SEC rules. Island maintained that its electronic form and the high degree of transparency that form entailed—providing, for example, an easy-to-follow audit trail for every order—would make enforcement far easier than in traditional securities markets. It would also provide Island with the opportunity to make millions of dollars in earnings every year from the sale of its market data.
After being fined for several trading violations, Island's parent Datek sold a 90 percent interest in Island to a group comprised of Bain Capital, TA Associates, and Silver Lake Partners. The sale was seen by some as an attempt to distance Island from Datek's problems while its exchange application was being considered. As of October 2001 the SEC had not handed down a decision on the application.
MEASURING UP TO COMPETITION
Island ECN offers investors a variety of advantages. It provides the flexibility of the longest trading session available. Island begins matching orders at 7:00 am, before the market opens, and continues until 8:00 pm, hours after the market has closed. It is able to do business much faster than traditional markets, with a speed as fast as 3/100ths of a second, compared to several seconds for traditional markets. That speed can be the difference between executing or failing to execute an order. Finally ECNs such as Island have cut the cost of trading significantly, charging fractions of a cent per share instead of five to six cents charged by traditional middlemen.
Island ECN has also shown itself to be more reliable than traditional markets. Between 1997 and the end of 2001, its system did not experience a single shutdown as a result of intensive volume. It accomplished this through a unique computer system designed to sustain heavy trading volumes. Rather than relying on a single mainframe computer, Island's system distributes work among hundreds of linked personal computers. Each PC in the system performs a single function, for example receiving orders, matching orders, or canceling orders. At the same time, the PCs back each other up. If one fails, another one running the same function takes over. Island's systems are required to comply with SEC standards governing security, capacity and reliability.
The system twice succeeded when NASDAQ's own system failed. First on January 3, 2001, and again on April 18, 2001, when announcements of interest-rate cuts by the Federal Reserve led to sudden, high-volume in trading, NASDAQ computers experienced delays in delivering execution messages. While the NASDAQ delays were occurring on January 3, Island continued to handle more than 10,000 orders a minute without a slowdown. Island had its highest volume day to date on October 4th, 2001, executing more than 550 million shares. Island's systems have been also internally benchmarked at handling well over 1,000 executions per second.
Andresen, Matthew, "Don't CLOBber ECNs." Wall Street Journal, March 27, 2000.
"Island ECN Calls on Congress to Revamp National National Market System, Eliminating ITS." Daily Report fot Executives, April 18, 2001.
"Island Won't Strand Traders." Active Trader, October 2001.
Kolbert, Elizabeth, "The Last Floor Show." New Yorker, March 20, 2000.
Pegg, Jonathan, "Driving Harder in a Bear Market to Pump Up Volume." Fortune Banker, April 2001.
Ponczak, Jeff, "Super, or Just So (es)-so?" Active Trader, October 2001.
Santini, Laura, "A Rebel's Gamble." Investment Dealers' Digest, January 29, 2001.
SEE ALSO: Archipelago Holdings LLC; Day Trading; Electronic Communications Networks (ECNs); Instinet Corp.; Investing, Online; Nasdaq Stock Market