Competition in the world of exchange-traded funds is no longer just to attract investors. The New York Stock Exchange and the American Stock Exchange have engaged in a pricing battle over ETFs, trying to lure asset managers to their respective floors. As the NYSE has eliminated transaction fees on ETFs, AMEX has done the same - all in an attempt to become the leading exchange for ETFs.
Last month, the NYSE began trading 27 AMEX-listed ETFs without charging a transaction fee. The NYSE made a similar move in April 2001, when it began trading, without fees, the QQQ (based on the Nasdaq 100 Index), the SPDR (based on the S&P 500) and the Diamonds (based on the Dow Jones Industrial Average).
Just as the AMEX responded a year ago by eliminating transaction fees on the three ETFs, the exchange has once again reacted to the NYSE's challenge by suspending transaction charges on the 27 ETFs.
"Obviously, we did that to maintain a competitive, level playing field," said Bob Rendine, senior VP at the AMEX, who said that the fee suspension was indeed a direct result of the NYSE's actions. "We're not going to allow them to gain any sort of competitive advantage."
Transaction charges on ETFs can, of course, be highly lucrative. In the first quarter of 2002, the AMEX traded an average of almost 32.5 million shares a day.
The transaction charges that the NYSE has suspended are identical to those of the AMEX, said Diana DeSocio, a spokeswoman for the NYSE. Before the suspension, both exchanges had been charging specialists 63 cents per 100 shares, registered traders 73 cents per 100 shares and off-floor broker/dealers 60 cents per 100 shares. The NYSE has waived those charges until June, and will reevaluate the situation then, DeSocio said.
The 31 ETFs that now trade on the NYSE without transaction fees are also trading on the basis of unlisted trading privileges (UTP), which means that the ETF sponsors do not have to pay the NYSE a listing fee.
"It's an offensive strategy on the part of the New York to capture market share," said Don Cassidy, senior fund analyst at Lipper of New York. "It's pretty aggressive of them."
When the NYSE began trading three ETFs listed on the AMEX in April of 2001 without transaction fees, it immediately started taking trading volume away from the AMEX. In March 2002, the NYSE accounted for 9.1% of the trading volume of the QQQ's, the most heavily traded ETF, according to New York-based Reuters. The AMEX accounted for 20%.
However, with only one asset manager paying listing fees for one ETF on the NYSE, the exchange has lagged behind the AMEX in terms of listing fees, as the AMEX lists 117 of the 119 domestic ETFs.
"Presumably, they're hoping that the next bunch of ETFs that somebody wants to trade might go [to the NYSE] instead of to the AMEX," Cassidy said. "I guess the best defense is a good offense."
How long the NYSE can offer ETFs without these fees is unclear. The listing fees on the NYSE are normally $5,000 initially and $2,000 annually thereafter, according to DeSocio.
"Ultimately you'd think that without a listing fee, the [NYSE] would be at a slight disadvantage," Cassidy said. "On the other hand, maybe they're willing to take a small loss to attract listings. It's like the Internet companies were: Grab market share and worry about profits later."
Whatever the loss the NYSE might be willing to endure, the AMEX does not want to relinquish its dominance in the ETF marketplace and allow its rival to gain any market share, Rendine said.
"We list 117 of the 119 ETFs. It's pretty clear that this is the home of exchange-traded funds," Rendine said. "New York hasn't been able to do that. They haven't gotten home-grown ETFs listed. And now they're doing something they've never done in their history by [waiving listing fees for] another exchange's products. We're simply not going to allow that to go unchallenged."
The AMEX and NYSE are not alone in the ETF marketplace, however. In fact, New York-based Island, one of the largest electronic communication networks (ECNs), surpassed the AMEX in QQQ trading last October. In March, Island handled 33.3% of the QQQ's trading volume, compared to the AMEX's 20% and the NYSE's 9.1%.
Although Island charges transaction fees, the firm is well suited for order trading and computer model transactions used by sophisticated investors, such as hedge funds, and especially for large orders, said Andrew Goldman, an executive VP at Island. The ECN does not charge fees to enter and then cancel orders, and it offers a speed of transaction fulfillment that is not available at the AMEX or NYSE, Goldman said.
The ECN also offers rebates for traders who post initial bids, thereby adding liquidity. In addition, Island rebates back to traders a portion of whatever money it receives from sharing market data. Because of the ECN's specialized customers, it is less in competition with the AMEX and NYSE than they are with each other, Goldman said.
"I think what's going on is that the AMEX and New York Stock Exchange are competing for the same group of customers," Goldman said. "New York came in and tried to scoop up new ETFs. What happened was they started to cannibalize the AMEX's trading volume."
However, the AMEX does not see it that way. The AMEX dominated the trading volume of the QQQs for a long time and, despite having lost its number one spot to Island, the exchange is intent on maintaining its ETF dominance overall, according to an AMEX spokeswoman.
The loser in this price war could be investors, according to Cassidy. The suspended fees will likely benefit the asset managers and the brokers, but investors will still be charged commissions. The downside for them might be a reduction in liquidity, which has always been a concern with ETFs.
"You really want to have a liquid market with these products. Dividing up the trading of [ETFs] could [result in less] liquidity," Cassidy said. Ultimately, that "could hurt investors," he added.
Fractionalizing the marketplace by having the same security trading on multiple exchanges can reduce liquidity because it may be harder to link buyers and sellers. Someone might be raising the bid on one exchange while someone else is lowering an ask on another exchange, and there's no guarantee they'll ever find each other, Cassidy said.
It is possible that the reduction of listing fees, if sustained, could be passed onto investors, but that decrease would likely be too small to have any material impact, Cassidy said. "I guess they could maybe move from 15 basis points to 14 over time," Cassidy said, "but does anyone really care about one basis point?"