electronic communication

An electronic communication network (ECN) is the term used in financial circles for a type of computer system that facilitates trading of financial products outside of stock exchanges. The primary products that are traded on ECNs are stocks and currencies. ECNs came into existence in 1998 when the SEC authorized their creation. ECNs increase competition among trading firms by lowering transaction costs, giving clients full access to their order books, and offering order matching outside of traditional exchange hours.

The functioning of ECNs

In order to trade with an ECN, one must be a subscriber or have an account with a broker that provides direct access trading. ECN subscribers can enter orders into the ECN via a custom computer terminal or network protocols. The ECN will then match contra-side orders (i.e. a sell-order is "contra-side" to a buy-order with the same price and share count) for execution. The ECN will post unmatched orders on the system for other subscribers to view. Generally, the buyer and seller are anonymous, with the trade execution reports listing the ECN as the party.

Some ECNs may offer additional features to subscribers such as negotiation, reserve size, and pegging, and may have access to the entire ECN book (as opposed to the "top of the book") that contains important real-time market data regarding depth of trading interest.

ECNs and the stock market

For stock, ECNs exist as a class of SEC-permitted Alternative Trading Systems (ATS). As an ATS, ECNs exclude broker-dealers' internal crossing networks – i.e., systems that match orders at the broker-dealer using prices from an exchange, without actually sending the order to a public venue.

ECN fee structure

ECN's fee structure can be grouped in two basic structures: a classic structure and a credit (or rebate) structure. Both fee structures offer advantages of their own. The classic structure tends to attract liquidity removers while the credit structure appeals to liquidity providers. However since both removers and providers of liquidity are necessary to create a market ECNs have to choose their fee structure carefully.

In a credit structure ECNs make a profit from paying liquidity providers a credit while charging a debit to liquidity removers. Their fees range from $0.002 to $0.0027 per share for liquidity providers, and $0.003 to $0.0025 per share for liquidity removers. The fee can be determined by monthly volume provided and removed, or by a fix structure, depending on the ECN, and it's known as a liquidity rebate, or credit. This structure is common on the NASDAQ market. In a classic structure, the ECN will charge a small fee to all market participants using their network, both liquidity providers and removers. They can also give lower price to large liquidity providers in order to attract volume to their networks. Fees for ECNs that operate under a classic structure range from $0 to $0.0015, or even higher depending on each ECN. This fee structure is more common in the NYSE, however recently some ECNs have moved their NYSE operations into a credit structure.

ECNs and the currency market

FX ECN like Baxter-FX, provide access to an electronic trading network, supplied with streaming quotes from the top tier banks in the world. The matching engine performs limit checks and matches orders in less than 100 milliseconds per trade. The matching is quote driven and these are the prices that match against all orders. Spreads are discretionary but in general multibank competition creates 1-2 ticks on Majors and Euro Crosses. The order book is not a routing system that sends orders to individual market makers. It is a live exchange type book working against the best bid/offer of all quotes. By trading through an ECN, a currency trader generally benefits from greater price transparency, faster processing, increased liquidity and more availability in the marketplace. The banks also reduce their costs as there is less manual involvement.


The first true ECN was the Nasdaq over-the-counter quotation system, created by the National Association of Securities Dealers in February 1971 after Joe McCulley provided information to Sperry-Rand in 1968 concerning the structure of an electronic marketplace. A 1964 Securities and Exchange Commission investigation into the opacity of the over the counter markets provided the impetus for creating the NASDAQ. Nasdaq was created following a 1969 American Stock Exchange study estimated that errors in hand-written securities order processing cost brokerage firms approximately $100 million per year. The Nasdaq system automated such order processing and provided brokers with the latest competitive price quotes via a computer terminal. Later, more advanced ECNs would develop from regulatory changes that developed out of a 1994 U.S. Justice Department investigation of possible antitrust violations by Nasdaq itself. This antitrust investigation was sparked by a March 1994 study by two economists, William Christie and Paul Schultz, which noted that Nasdaq bid-ask spreads were larger than was statistically likely, indicating "an implicit agreement among market makers to avoid using odd-eighths in quoting bid and ask prices..." As part of Nasdaq's settlement of these antitrust charges, Nasdaq adopted new order handling rules that integrated ECNs into the Nasdaq system. Shortly after this settlement, the SEC adopted Regulation ATS, which permitted ECNs the option of registering as stock exchanges or else being regulated under a separate set of standards for ECNs.

Major ECNs that became active at this time were Instinet and Island (part of Instinet was spun off, merged with Island into INET, and acquired by NASDAQ), Archipelago Exchange (which was acquired by the NYSE) and Brut (now acquired by NASDAQ). Another example of an ECN would be Bloomberg's TradeBook.

ECNs have enjoyed a resurgence since the adoption of SEC Regulation NMS, which required "trade through" protection of orders in the market, regardless of where those orders are placed. The most prominent ECNs currently are Direct Edge ECN (owned by a consortium of Knight Capital Group, Citadel, and Goldman Sachs) BATS Trading and Baxter-FX.

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