ECNs: innovation, competition and consolidation

ECNs became a new breed of financial markets intermediaries when the SEC’s Order Handling Rules came into effect in 1997, with the goal of better protecting customers’ limit orders and fostering competition in the NASDAQ marketplace. At one point, there were as many as 12 ECNs, but only a handful still exist today and consolidation in that space might not be over yet.

Now known as Inet, Island wrote many pages of the history of the ECNs, largely due to its technology—developed by chief IT architect Josh Levine—and its aggressive stand for market structure reforms, advocated by Island then-President Matthew Andresen.

Island spearheaded the fight against the trade-through rule, highlighting the shortcomings of the floor-based auction system vs. auto-execution electronic systems. Seen as an intellectual oddity at first and met with bitter opposition later, Island’s anti-trade-through fight bore results: it led the SEC to propose major reforms in 2004 to modernize U.S. capital markets with Regulation NMS.

Island was part of the Datek Online Holdings group, which came under regulatory scrutiny and was forced to enter one of the largest settlements ever reached with a single firm. Under a new management led by Ed Nicoll beginning in 1999, Datek capitalized on its strength—technology—and was subsequently sold to Ameritrade for $1.3 billion.

The deal did not include Island, which was eventually bought by Instinet, the founder of the electronic agency brokerage business, in September 2002. Majority-owned by British market data and information services provider Reuters, Instinet merged its own ECN platform with Island’s to create a mega-ECN, Inet. Instinet also separated its brokerage and ECN businesses. Yet, the merger and restructuring failed to yield lofty profits and Reuters has put the Instinet group on the auction block, with a sale likely to be announced soon.

Instinet made its debut in 1969, as Institutional Network Corp., a financial services provider for the buy-side. By allowing other broker-dealers as members in the mid-1980s, Instinet de facto became the central limit order book for the NASDAQ market, more than a decade before the SEC’s Order Handling Rules.