[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
DECIMAL CONVERSION 2000: ARE THE MARKETS READY?
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
FINANCE AND HAZARDOUS MATERIALS
of the
COMMITTEE ON COMMERCE
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
SECOND SESSION
__________
MARCH 1, 2000
__________
Serial No. 106-113
__________
Printed for the use of the Committee on Commerce
U.S. GOVERNMENT PRINTING OFFICE
62-974 CC WASHINGTON : 2000
COMMITTEE ON COMMERCE
TOM BLILEY, Virginia, Chairman
W.J. ``BILLY'' TAUZIN, Louisiana JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio HENRY A. WAXMAN, California
MICHAEL BILIRAKIS, Florida EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas RALPH M. HALL, Texas
FRED UPTON, Michigan RICK BOUCHER, Virginia
CLIFF STEARNS, Florida EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio FRANK PALLONE, Jr., New Jersey
Vice Chairman SHERROD BROWN, Ohio
JAMES C. GREENWOOD, Pennsylvania BART GORDON, Tennessee
CHRISTOPHER COX, California PETER DEUTSCH, Florida
NATHAN DEAL, Georgia BOBBY L. RUSH, Illinois
STEVE LARGENT, Oklahoma ANNA G. ESHOO, California
RICHARD BURR, North Carolina RON KLINK, Pennsylvania
BRIAN P. BILBRAY, California BART STUPAK, Michigan
ED WHITFIELD, Kentucky ELIOT L. ENGEL, New York
GREG GANSKE, Iowa TOM SAWYER, Ohio
CHARLIE NORWOOD, Georgia ALBERT R. WYNN, Maryland
TOM A. COBURN, Oklahoma GENE GREEN, Texas
RICK LAZIO, New York KAREN McCARTHY, Missouri
BARBARA CUBIN, Wyoming TED STRICKLAND, Ohio
JAMES E. ROGAN, California DIANA DeGETTE, Colorado
JOHN SHIMKUS, Illinois THOMAS M. BARRETT, Wisconsin
HEATHER WILSON, New Mexico BILL LUTHER, Minnesota
JOHN B. SHADEGG, Arizona LOIS CAPPS, California
CHARLES W. ``CHIP'' PICKERING,
Mississippi
VITO FOSSELLA, New York
ROY BLUNT, Missouri
ED BRYANT, Tennessee
ROBERT L. EHRLICH, Jr., Maryland
James E. Derderian, Chief of Staff
James D. Barnette, General Counsel
Reid P.F. Stuntz, Minority Staff Director and Chief Counsel
______
Subcommittee on Finance and Hazardous Materials
MICHAEL G. OXLEY, Ohio, Chairman
W.J. ``BILLY'' TAUZIN, Louisiana EDOLPHUS TOWNS, New York
Vice Chairman PETER DEUTSCH, Florida
PAUL E. GILLMOR, Ohio BART STUPAK, Michigan
JAMES C. GREENWOOD, Pennsylvania ELIOT L. ENGEL, New York
CHRISTOPHER COX, California DIANA DeGETTE, Colorado
STEVE LARGENT, Oklahoma THOMAS M. BARRETT, Wisconsin
BRIAN P. BILBRAY, California BILL LUTHER, Minnesota
GREG GANSKE, Iowa LOIS CAPPS, California
RICK LAZIO, New York EDWARD J. MARKEY, Massachusetts
JOHN SHIMKUS, Illinois RALPH M. HALL, Texas
HEATHER WILSON, New Mexico FRANK PALLONE, Jr., New Jersey
JOHN B. SHADEGG, Arizona BOBBY L. RUSH, Illinois
VITO FOSSELLA, New York JOHN D. DINGELL, Michigan,
ROY BLUNT, Missouri (Ex Officio)
ROBERT L. EHRLICH, Jr., Maryland
TOM BLILEY, Virginia,
(Ex Officio)
(ii)
C O N T E N T S
__________
Page
Testimony of:
D'Agostino, Davi M., Acting Associate Director for Financial
Institutions and Markets Issues, General Government
Division; accompanied by Cody J. Goebel, Associate Director
for Financial Institutions and Markets Issues; and Jean-
Paul Reveyoso, Senior Evaluator for Financial Institutions
and Markets Issues, General Accounting Office.............. 4
Material submitted for the record by:
Berkeley, Alfred R., letter dated March 31, 2000, to Hon.
John D. Dingell, enclosing response for the record......... 65
Brodsky, William J., letter dated March 30, 2000, to Hon.
John D. Dingell, enclosing response for the record......... 80
DeFoe, Philip D., letter dated April 10, 2000, to Hon. John
D. Dingell, enclosing response for the record.............. 84
Dingell, Hon. John D., a Representative in Congress from the
State of Michigan:
Letter dated March 2, 2000, to Hon. Michael G. Oxley..... 59
Letter dated March 2, 2000, to Alfred R. Berkeley,
requesting response for the record..................... 60
Letter dated March 2, 2000, to William J. Brodsky,
requesting response for the record..................... 62
Letter dated March 2, 2000, to Philip D. DeFoe,
requesting response for the record..................... 62
Letter dated March 2, 2000, to Meyer S. Frucher,
requesting response for the record..................... 62
Letter dated March 2, 2000, to Salvatore F. Sodano,
requesting response for the record..................... 62
Letter dated March 2, 2000, to David Krell, requesting
response for the record................................ 62
Krell, David, letter dated March 30, 2000, to Hon. John D.
Dingell, enclosing response for the record................. 96
Sodano, Salvatore F., letter dated March 31, 2000, to Hon.
John D. Dingell, enclosing response for the record......... 91
(iii)
DECIMAL CONVERSION 2000: ARE THE MARKETS READY?
----------
WEDNESDAY, MARCH 1, 2000
House of Representatives,
Committee on Commerce,
Subcommittee on Finance and Hazardous Materials,
Washington, DC.
The subcommittee met, pursuant to notice at 10 a.m., in
room 2322, Rayburn House Office Building, Hon. Michael G. Oxley
(chairman) presiding.
Members present: Representatives Oxley, Shimkus, Wilson,
Fossella, Ehrlich, Towns, Engel, Luther, Capps, and Markey.
Staff present: David Cavicke, majority counsel; Linda
Dallas Rich, majority counsel; Brian McCullough, majority
professional staff; Robert Simison, legislative clerk; Consuela
Washington, minority counsel.
Mr. Oxley. The subcommittee will come to order. The Chair
will recognize himself for an opening statement.
Three years ago this committee led the effort to get the
securities markets to convert from fractions to decimals. It
was an important change. I wanted to do this for three reasons.
One, I believe the free market, not the Government should
determine stock prices; two, decimals would make the markets
more accessible because they are easier to understand than
fractions; and, three, decimals would promote the
competitiveness of the U.S. stock markets because the rest of
the world is already trading in decimals.
After we reported legislation the exchanges agreed that
they would convert to decimals. We agreed to let the markets
convert after their Y2K efforts. Now that the Y2K computer
crunch has come and gone, mercifully, we thought it a good time
to see how the markets are doing on decimal conversion.
Based on my recent visit to New York with our colleague
Vito Fossella, and my review of the GAO testimony, the answer
is, we're in pretty good shape. The markets are on schedule to
convert this July. Initially there will be a spread of a nickel
for most stocks. After we have had decimal trading for about 6
months, we anticipate that there will be no mandated minimum
increment and we will have full free market pricing in
decimals.
I understand that some firms in the options exchanges may
experience some difficulties because of increased trading and
message traffic that decimals will bring. We are phasing in
decimals by providing for the nickel increments in an attempt
to alleviate those problems.
Additionally, I'm open to other solutions that will help
the options exchanges to get through this transition. Decimals
was a good bipartisan achievement of which we can all be proud.
I appreciate the work that the GAO has done, in monitoring
decimal conversion for us and look forward to the GAO's
testimony.
And with that the Chair yields back and is now pleased to
recognize the ranking member, the gentleman from New York, Mr.
Towns.
Mr. Towns. Thank you very much, Mr. Chairman.
In the 105th Congress you proposed a bill that was so
simple it was monumental. Your bill H.R. 1053 required our
markets to join the rest of the world and price stocks in
decimals rather than in fractions. After our passing the bill
out of subcommittee, the market participants agreed that it was
time to enter the 21st Century by converting to decimals.
Now we are on the verge of reaching our goal; the markets
were able to successfully navigate Y2K and they are now poised
to conquer the next important task, converting from fractions
to dollars and cents. While I'm anxious to see decimal
conversion, I am a little concerned about some details.
Fortunately my concern arises from one of the benefits that
will occur in the market once it converts from fractions.
Due to the increase of ``traffic'' that is bound to occur
with decimalization, I'm concerned about whether or not there
is enough capacity in our trading system to handle the new flow
of information being created by shrinking bid and offer quotes.
It is vital to ensure that our system has the ability to handle
this conversion. I hope that the testimony from the General
Accounting Office will be able to alleviate any concerns that I
have in this area.
I would like to applaud the industry who have worked to
ensure that our capital markets will be ready to trade in
decimals by July. Their steadfast commitment on this issue will
help solidify that our markets remain the envy of the world and
easier for every American to understand.
I would also like to congratulate you, Mr. Chairman, for
your leadership on this issue. It's been a very important
victory for American investors in our Nation's capital markets.
I thank the GAO for their testimony today and look forward to
hearing just how ready our markets are for decimal conversion.
Thank you very much, Mr. Chairman, again for having this
hearing, and I yield back.
Mr. Oxley. Thank you.
[Additional statements submitted for the record follow:]
Prepared Statement of Hon. Tom Bliley, Chairman, Committee on Commerce
During the 105th Congress, Finance and Hazardous Materials
Subcommittee Chairman Mike Oxley proposed a very good idea--H.R. 1053,
the Common Cents Stock Pricing Act of 1997. His bill would have
required our nation's exchanges to price stock in dollars and cents,
rather than in government set fractions.
I was an original co-sponsor of H.R. 1053. I agree with Chairman
Oxley that pricing stocks in decimals will benefit American investors
and our capital markets. Listing stock in decimals will make the ticker
on the bottom of CNBC easier to understand for every American. It will
also make our markets more competitive by allowing the market to
determine the buy and sell price, rather than a government mandated
spread.
Today I am pleased to see that decimal pricing is just around the
corner. The Securities and Exchange Commission and the industry have
worked together to ensure that our capital markets will be trading
stocks in decimals, rather than fractions, by July of this year. We are
here today to hear from the General Accounting Office about the
progress that has been made towards this goal.
I congratulate Chairman Oxley, and Telecommunications, Trade, and
Consumer Protection Ranking Member Ed Markey for their hard work which
has led to an important victory for American investors and all
participants in our nation's capital markets.
I also thank the GAO for their review of the industry preparedness,
and look forward to their testimony today.
______
Prepared Statement of Hon. Edward J. Markey, a Representative in
Congress from the State of Massachusetts
Thank you, Mr. Chairman.
I would like to begin by commending you for calling today's hearing
and for your persistent leadership over the last two years in pushing
our nation's stock markets to move away from trading in fractions and
towards trading in dollars and cents. This is an important pro-consumer
initiative that will make our markets more efficient and competitive
and save investors billions of dollars in lower trading costs.
Three years ago this month, I joined with you, with Chairman
Bliley, and several other Members of the Committee in introducing H.R.
1053, the ``Common Cents Stock Pricing Act of 1997.'' We introduced
this legislation to correct an absurd anomaly in our nation's stock and
options markets. More than two centuries after traders meet under the
Buttonwood tree in lower Manhattan to form the New York Stock Exchange,
stocks were still trading in increments of an eighth of a dollar--or
12\1/2\ cents. Some financial historians attribute this arcane practice
to the time when the Spanish dollar was a widely used currency in
America. These Spanish dollars routinely were cut up into ``bits'' or
``pieces of eight.'' Others suggest that the eighth could also be
derived from the old ``New York dollar,'' a regional currency used
during the early years of the Republic.
Regardless of its origin, 200 years later, the rest of the America
had long since moved on to buying and selling goods and services using
dollars and cents. Clearly, it was time for the securities industry to
catch up.
Despite the protests of some in the industry that the issue was too
complex, that we needed more hearings, that we'd destroy the
profitability of the brokerage industry, this Subcommittee moved
forward to approve our bill and direct the SEC to mandate a move to
decimal pricing. And once we acted, the markets responded. The New York
Stock Exchange, the NASDAQ, and the regional exchanges announced that
they would immediately move from eighths to 16ths in preparation for a
move to decimals in the summer of 2000. In response to this welcome and
forward looking change of heart on the part of the securities industry,
we decided to withhold further action on H.R. 1057 and closely monitor
industry progress towards meeting the goal.
As part of the Subcommittee's ongoing oversight efforts, I joined
with you and Chairman Bliley last year to ask the General Accounting
Office to monitor what actions were being undertaken by the SEC, the
exchanges, and Wall Street securities firms to make decimal pricing a
reality. Today, we will be hearing from GAO on their findings and
recommendations. The good news is that progress is being made. The bad
news is that a number of challenges still remain and some in the
industry may be dragging their feet. We will hear that the primary
challenge is the systems capacity of the computers and
telecommunications systems used to transact trading, and that these
challenges are particularly acute for the options exchanges. We will
also hear that concerns about antitrust issues may have delayed efforts
to develop market standards and exchange rules relating to decimal
trading.
Based on my review of GAO's testimony, I am convinced that it is
possible for the industry to meet the deadlines for an orderly
transition to decimals--if the industry has the willpower to do so. The
SEC needs to be vigilant in pressing all market participants forward to
decimals, and be willing to let market forces--rather than artificial
exchange rules--set the minimum price increment for stocks. I continue
to hear disturbing rumors that some in the industry might want to delay
the move to decimals, or permanently lock in a nickel trading increment
for stocks. This concerns me. The industry has now had three years to
get ready. It's time for industry to do their bit, get off the dime,
and give stock investors the opportunity to profit from spreads that
range down to a penny.
Thanks again, Mr. Chairman, for calling today's hearing. I look
forward to hearing the testimony.
Mr. Oxley. If there are no further openings statements then
let me turn now to our distinguished witness, she is Ms. Davi
M. D'Agostino, Acting Associate Director for Financial
Institutions and Markets issues with GAO in the General
Government Division. Ms. D'Agostino thank you for being with us
today. And if you will, would you identify and introduce your
cohorts here at the table.
Ms. D'Agostino. Yes, I'd be happy to. And thank you for
inviting us.
This is Mr. Jean-Paul Reveyoso, Mr. Cody Goebel, and Mr.
Keith Rhodes, our chief scientist.
Mr. Oxley. Thank you. And you may proceed.
STATEMENT OF DAVI M. D'AGOSTINO, ACTING ASSOCIATE DIRECTOR FOR
FINANCIAL INSTITUTIONS AND MARKETS ISSUES, GENERAL GOVERNMENT
DIVISION; ACCOMPANIED BY CODY J. GOEBEL, ASSOCIATE DIRECTOR FOR
FINANCIAL INSTITUTIONS AND MARKETS ISSUES; AND JEAN-PAUL
REVEYOSO, SENIOR EVALUATOR FOR FINANCIAL INSTITUTIONS AND
MARKETS ISSUES, GENERAL ACCOUNTING OFFICE
Ms. D'Agostino. Okay. Good morning, everyone.
You asked us here this morning to discuss GAO's
observations on the securities industry's progress toward
implementing decimal trading. As you know, GAO has bee
monitoring this issue at your request and testified on the
actions needed to convert to decimals nearly 2 years ago.
May I submit my full statement for the record and summarize
my remarks.
Mr. Oxley. Without objection.
Ms. D'Agostino. Okay. Thank you.
I'm going to focus my remarks today on three key areas.
First I will discuss the progress made to date for converting
to decimals. Second, I'll highlight some of the challenges that
lie ahead for the U.S. securities industry to successfully
trade at decimal prices. And third, I'll briefly cover some of
the areas where we plan to focus our future efforts at your
request and monitoring the industry.
In 1998 testimony before this subcommittee GAO recommended
that the Chairman of Securities and Exchange Commission or the
SEC ensure decimal pricing got implemented in a timely manner
after the industry prepared for the year 2000 date change. Most
importantly, we recommended that SEC ensure that the industry
establish definitive timeframes for implementing decimal
trading and assess the impact of decimal trading on the
industry's processing and communication systems capacities.
SEC and the industry have taken actions to ensure that the
markets begin decimal pricing in 2000. SEC has monitored the
industry efforts coordinated by the Securities Industry
Association, the SIA, to develop a plan, a schedule and
standards for decimal pricing. SEC also issued two orders
directing the industry participants to work jointly on these
tasks. Importantly, SEC's most recent order issued on January
28, directs the stock and options and exchanges and the NASD to
coordinate on a plan to begin decimal trading, as you said, by
July 3, 2000.
Also very importantly, SIA did commission a study of
decimals impact on trading and quotation volumes. And the
industry has now scheduled three industry-wide tests of decimal
trading in April, May and June of this year. Details of the
industry's plan are in a state of flux right now and things may
change, but the illustration on your left shows some of the
more detailed recent thinking on the phase schedule for
implementing decimals.
The industry plans a first phase to start in July 2000 as
called for in the SEC order. And during that first month a
small number of stocks, about 30, as discussed earlier this
month at the SIA will be switched from fractions to decimal
pricing in no greater than nickel increments.
A second phase would then begin in which all stocks would
be switched to decimals. At the same time the industry would
pilot some number of stocks to be traded in penny increments.
After January 2001, the final phase would begin in which
individual markets would seek SEC approval for the specific
increments in which they intend to quote their decimal prices.
This phase is expected to end March 3, 2001.
While these SEC and securities industry efforts and
activities represent progress in preparing for trading in
decimals, some key challenges in our view remain ahead for
success. Possibly one of the most serious challenges facing the
industry is the systems capacity demands that Mr. Towns
mentioned of decimal trading and quoting as projected by an
industry study.
A private firm, SRI Consulting, did this study for the
industry and its most recently updated projections show
substantial increases in message traffic can be expected. The
most striking increases in message traffic in a decimal/penny
trading environment are projected in the options markets and
the Nasdaq. The illustration board on your right shows the SRI
projection that the options peak message traffic could increase
over 3,000 percent from December 1998 levels by December 2001
if trading is in penny increments.
They also projected that Nasdaq's peak message traffic
could increase by 700 percent in the same period if trading is
in pennies.
It's important to note that SRI's projections take into
account much more than just switching to decimal pricing. They
also take into account recent record volumes in trading and
increased competition among the options exchanges.
Now, both the Options Price Reporting Authority or the OPRA
and the Nasdaq are already having difficulty meeting message
traffic demands with current capacity.
OPRA plans to increase its capacity by the end of the year
2000, but that increased capacity will still be less than one-
third of what SRI projects as needed to quote in penny minimum
price variations, MPV. Even if OPRA could meet the needed
capacity, the price changes would occur so quickly that human
traders watching the computer screens might not be able to keep
up. As a result OPRA is also taking steps to reduce quotation
message traffic such as setting internal priorities on its own
quote and trade reports.
Other proposals are to discontinue price quotes for options
with low trading volumes and establish minimum increments of
five or ten cents for options quotations. In any case, because
of potential market implications of these steps the SEC will
have to review the proposals and approve any needed changes to
rules. The Nasdaq has told SEC that they would not be ready to
fully deal with their own lower projections of message traffic
volumes until the first quarter of 2001. Under its current
plans, Nasdaq will not be prepared to deal with message traffic
volumes projected by SRI.
In addition, because of capacity issues and readiness
issues, Nasdaq will not be able to participate in the first two
tests scheduled for April and May this year, and instead they
plan to join the June 2000 test.
Beyond the critical capacity challenge, industry
participants need to work closely together in several areas to
successfully convert to decimal trading in a timely manner. For
example, industry must cooperate to finalize standards for
market operations and practices. However, cooperation and
progress in developing market standards has been hampered by
antitrust concerns. Despite SEC and Justice Department efforts
to mitigate these concerns, industry meetings on decimal-
related market standards were not proceeding because of an
ongoing antitrust investigation of the options markets and
pending lawsuits.
However, the January 28 SEC order, that I mentioned
earlier, clearly states that industry cooperation in discussing
developing and implementing decimal trading is imperative and
in the public interest. And this order is expected to remove
any further industry unwillingness to cooperate on decimals
because of antitrust concerns.
Other challenges remaining for the industry include
assessing and proposing revised exchange and market rules as
may be needed to accommodate decimal trading and readying the
systems of the exchanges, broker-dealers, the vendors, and
others for decimal prices.
SEC has been encouraging the industry to address the needed
rule changes and has been also examining the readiness of
various firms' systems for dealing with decimals.
Now, as part of our continuing efforts to monitor the
industry's progress at your request, we plan to stay on top of
a number of different aspects of their efforts. We want to
continue to focus on the approval process for market rule
changes, the regulators' readiness assessments of broker-dealer
systems to handle decimals, and the results of the tests
conducted among the exchanges and the member firms.
In addition, we want to look at what the various industry
committees are doing on market standards and implementation
procedures.
Mr. Chairman and members of the subcommittee that concludes
my summary and we would be happy the answer any questions you
have at this time.
[The prepared statement of Davi M. D'Agostino follows:]
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Mr. Oxley. Thank you very much, Ms. D'Agostino and the
Chair would recognize himself for 5 minutes for questions.
Addressing the challenges that you pointed out, I take it
that the clearly overriding challenge is on the capacity issue;
is that correct?
Ms. D'Agostino. That's our assessment, yes. That seems to
be the most difficult challenge ahead, I think.
Mr. Oxley. Now, there have been some, including myself,
that have tried to draw a similarity between the conversion to
Y2K and conversion to decimals. And I know the GAO had been
involved--maybe not you personally, but obviously in that
issue. Are there some parallels here, are some of the fears
that were there with Y2K that proved not to be the case also
perhaps the same kind of fears that are addressed with the
conversion to decimals?
Ms. D'Agostino. I think it's a little bit of a different
problem because it mixes the actual physical change to decimal
pricing which isn't all that difficult a problem with the
record volumes that the industry is experiencing even without
decimals and that compounded with the expected increases in
trading from moving to decimals as the spreads narrow. So its
capacity.
Mr. Oxley. Now the demonstration you have in front of us
here indicating the phases of converting to decimals, this is
the industry draft as opposed to what the SEC had proposed; is
that correct?
Ms. D'Agostino. It's actually right in alignment with what
the SEC order lays out. The question is, what happens in the
middle there? The beginning date is the same, and I think the
end date is the same, the question is, how long it takes to
actually convert, how long the pilot is, and the increments at
which each of the markets and which stocks would trade. And I
think the order gives the industry that wiggle room in the
middle to do what it thinks is prudent.
Mr. Oxley. And as I understand it from the SEC, based on a
meeting we had with Mr. Fossella last week, in New York, that
the SEC is also still seeking comment and suggestions that they
appear to be flexible in trying to make this work to
everybody's satisfaction to get to the goal, but to get to the
goal the right way.
The capacity issue even if we didn't have decimals would
be, according to your testimony, a problem anyway; is that
correct?
Ms. D'Agostino. Right now, yes, that's true, Mr. Chairman.
Mr. Oxley. And is this a--aside from what's going on out
there, is this basically a technological problem? The capacity
issue in and of itself appears to be a challenge technically;
is that correct?
Ms. D'Agostino. Yes, it is. In fact, Mr. Rhodes, would you
like to respond to that?
Mr. Oxley. Would you identify yourself, again, for the
record, please?
Mr. Rhodes. My name is Keith Rhodes and I'm the Chief
Scientist of the General Accounting Office. And, yes, it is,
it's a technical issue in that if you look at how the message
traffic is being moved, what you are trying to do is take a
ten-inch fire hose and hook it up to a soda straw. And what you
have to do is make certain that the soda straw is as large as
the ten-inch fire hose. And whether the stock market or whether
the markets in general go to decimals, as we've seen, there are
already capacity problems that exist and these will just be
compounded. But it is purely a technology problem.
Mr. Oxley. Ms. D'Agostino, could you give us an idea as to
who you talk to, market participants and the like, not
specifically individuals, but I mean, in your study who did you
talk to and was in fact the capacity issue the No. 1 concern at
least in the markets?
Ms. D'Agostino. The team has basically attended or sat in
on otherwise telephonically every single SIA meeting that's
occurred on this matter, and has also been in contact with the
exchanges and Nasdaq. They've gotten some information from
Nasdaq that indicates and actually even raised our concerns
about the capacity issue to some extent very recently. The
options markets have raised this concern in OPRA to us, I mean,
in front of us and it's been an issue all along the way in the
discussions at SIA.
Mr. Oxley. Thank you. My time has expired, let me now
recognize the ranking member, the gentleman from New York.
Mr. Towns. Thank you very much, Mr. Chairman. Your
testimony indicates that the OPRA system for disseminating
options trade and price quote messages has a current capacity
of 3,000 messages per second. And that OPRA officials intend to
increase the capacity to 12,000 messages per second by the end
of the year.
Ms. D'Agostino. Right.
Mr. Towns. Your testimony goes on to say, ``however, this
additional capacity will not be adequate to accommodate the SRI
projections'' for quotation traffic. The options markets have
been taking a number of steps and propose to take a number of
steps to reduce traffic, but they also are not enough and will
have an adverse effect on the transparency of our options
market.
I am concerned that we have a problem--well, a disaster,
actually, in the making. What does GAO recommend that SEC and
the options markets can do to head off this serious problem as
I see it?
Ms. D'Agostino. Well, Mr. Towns, we actually just received
a copy of the proposal that OPRA submitted to the SEC. I think
SEC is just starting to take a look at it themselves. This
proposal lays out a whole number of options of opportunities or
ideas to reduce the message traffic volume. Some of these ideas
are ideas that are clearly not going to have a bad impact on
transparency. For example, if they delist inactive options,
that's not going to hurt transparency.
Some of the other ones, however, might cause concern about
transparency and that's why SEC, I think is going to take a
really hard look at each one of the strategies that OPRA has
proposed and consider it in terms of what might be needed in
terms of rule changes down the road if they do approve the
strategy.
Mr. Towns. Mr. Chairman, I would like to request that GAO
submit that for the record.
Mr. Oxley. Without objection.
Mr. Towns. Thank you very much.
[The information referred to follows:]
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Mr. Towns. Is there a commercially available system that
can handle the options volume anticipated under decimal
trading?
Ms. D'Agostino. Keith?
Mr. Rhodes. The standard systems that are being used, yes,
it's not a matter of a system has to be invented to handle
this. It's a matter of taking existing systems, and in the
discussions that we've had, it's a matter of adding additional
processors and additional computer systems in place and
additional capacity in terms of communications, new switches
and things like that. Nothing has to be invented to make this
increased capacity. It's a matter of something has to be
bought, has to be put i place, and it has to be tested. So
there's no--it's not that you can go to an off-the-shelf system
that says, here's a computer that will handle 32,000 options of
32,000 messages per second for options traffic at its ultimate
peak, it's a matter of going in and taking several computers or
several processors and putting them together and getting
multiples of faster switched in place. So there's nothing that
has to be invented to solve this problem, it's a matter of
taking existing technology and putting it in place.
Mr. Towns. So we have to be careful about these timetables?
Mr. Rhodes. Yes, we do.
Mr. Towns. As you know, the SEC recently approved the
application of the International Stock Exchange to operate as
the first electronic options exchange. Does the SRI study
include its volume projections? Would its operation further
raise capacity concerns or not?
Mr. Rhodes. I don't believe that the SRI numbers that we
include in our testimony include the ISC projections. But the
numbers that OPRA has been working with that are very similar
to the same level that SRI is projecting do include the impact
of the ISC with an additional buffer that they always try to
build in to have some excess capacity. But from what we could
see, the numbers were very comparable.
Mr. Towns. Do you want to add something to that? No.
All right. Let me thank you very much, Mr. Chairman. I
think that it's important that we continue this dialog because
I have some reservations, I must admit, you know, in fact, I
guess a better term, I'm a little nervous about it because
there's still a lot of uncertainties. And I think that we need
to be able to come up with some answers to some of these
questions. And on that note I yield back.
Mr. Oxley. The gentleman yields back. Let me inform the
ranking member that this is a first of probably a series of
hearings that we'll have on this important issue. We wanted to
set the stage with the GAO report and we appreciate their
testimony and the information that they're giving the
committee. This is of utmost importance for the markets and we
want to make certain that everything works smoothly. And this
is, again, the first step in that effort.
Mr. Towns. That calms me a little. That calms me down a
little bit. Thank you, Mr. Chairman.
Mr. Oxley. And the gentle lady from Mexico.
Ms. Wilson. Thank you, Mr. Chairman. I'm glad that the
ranking member is feeling comfortable.
Mr. Oxley. He's chilling.
Ms. Wilson. Mr. Chairman, I really just had a number of
kind of initial questions, and I have met with some of the
folks who are running the markets and I'm very glad to see this
change to decimals. I don't 6/18ths or 6/56ths and those kinds
of things and I was interested to see your projected increases
in volume.
I understand that there's also some research going on, and
I don't know if you're familiar with it, but it's really kind
of chaos theory research that has less to do with volume than
it does with change of behavior. And I see Mr. Rhodes nodding
his head, and I wonder if you could talk a little bit about
what some of that modeling is telling us about how behavior
might change in the stock market--and it's less relevant or
probably less significant when they go to dimes or nickels, but
there's some interesting questions about when they go to
pennies. And I wonder if you could share what you know?
Mr. Rhodes. If you're referring to the work out of the
Santa Fe Institute? Right. The idea is that you would take the
spread and you establish what are called ``strange attractors''
inside the structure of message traffic and show that there are
two directions that the volume can go. One is that you have
tremendous peaks, and then there are also views that the market
volume will actually rise higher or the volume--the domestic
traffic volume will rise higher than even the SRI projections.
So the concern there is that if you follow not just historical
data and not just estimates on the load, but you look at how
people operate and decisions that people make and the kinds of
decisions that they collect to, then you get this--you get
these series of spikes and it's not that overall you have
32,000 messages per second, it's that at any given point in
time you can have hundreds of thousands of messages at a peak
and 32,000 becomes sort of a gradual curve.
And, in a way, that follows some of the discussion that we
heard with the broker dealers because there were discussions
about, well, you know, nobody will trade at a nickel. You know,
everything will stay at a nickel and no one will go lower. And
then there were other traders who said, a nickel won't last
till lunchtime. So from the Santa Fe perspective, they're
figuring out how honest and true and reliable a nickel would be
versus a penny. And some of their theories are that it will go
to pennies immediately. And, therefore, the volume would rise
tremendously immediately.
Ms. Wilson. Is it a question of just volume or does
behavior change too? I mean, for example, how does that
affect--I don't know if I've got the right question or not----
Mr. Goebel. One of the things that the SRI study did when
it was estimating what the impact of nickels was, they could
draw on historical data because we've had experience in the
U.S. markets with the move from 8ths to 16ths, but the move
from there down to pennies was basically unprecedented for our
markets and literally for markets around the world even in
other exchanges. Overseas they trade usually in higher
increments than pennies. So what they did to try to estimate
how behavior--trading behavior would change was they went to
all of the range of various market participants--dealers,
upstairs traders, mutual fund, trading desk managers, that kind
of thing--to try to find out what those people would do in a
penny environment.
And in general the expectation is that whereas in the
current environment where someone may offer, say, 5,000 shares
to trade at a nickel, now if there's more price points, they
might offer a thousand at a penny, 2,000 at three cents, so the
volume that previously traded at one price might be spread over
a number of price points. And that's what creates this
additional quotation volume and additional trading. And that
experience is borne out on the markets, for instance, Toronto.
Ms. Wilson. Have they asked questions in these same kind of
studies and groups in the different players about whether
behavior is likely to change at a point of crisis or at a point
of rapid change in the stock market, or is that just really a
volume question?
Mr. Goebel. Yeah, I don't believe the SRI study took into
account analysis sort of market events occurring. And I think
they--as a matter of fact, they even qualified that their day
may not necessarily speak to what could occur in situations
like that.
Ms. Wilson. Okay. Thank you very much. Thank you, Mr.
Chairman.
Mr. Oxley. That time is expired. We turn to the gentle lady
from California, Ms. Capps.
Ms. Capps. Thank you, Mr. Chairman. I'm very pleased that
you called this hearing today, because obviously this is a very
important issue. And I appreciate the testimony that you have
given, Ms. D'Agostino, and for your colleagues being here, as
well updating us on the markets' conversion to decimals.
Ensuring that our stock markets are able to handle a decimal
conversion efficiently and smoothly is of great concern to all
Americans, whether or not they realize it. Once done, of
course, the goal is going to be terrific, saving consumers
billions of dollars, increasing liquidity in the markets,
encouraging investments. This is all to the good.
I'm still--I share Mr. Towns' nervousness, I guess. I'm
still concerned about the problems that you've pointed out and
I appreciate that you've addressed with the previous questioner
the studies themselves and the kind of confidence that GAO has
in the estimates that have been given, really, by the industry
itself.
If I could bring up one other issue for your comment--the
average daily trading volume on Nasdaq has increased 61 percent
over the last year and that due to that Nasdaq is experiencing
processing strains. How does this strain manifest itself? Is
this something that is generally appreciated and perceived by
the trading public?
Mr. Goebel. Yeah, we didn't do a lot of research on exactly
how those things were playing out for Nasdaq. From what we
understand some of their internal systems may be experiencing
queuing beyond those of the other systems, but they provided us
with some information indicating what plans they intend to take
to address the individual systems that as a group make up their
entire sort of trading infrastructure. And in some cases it
includes adding additional message switches and things like
that to take those bottlenecks out of the various components.
Ms. Capps. So they already have a system in place? For as
the smaller parts of this come to their attention that they can
pull into place?
Mr. Goebel. From their response, they're attempting to
increase capacities and processing capabilities in all the
various parts, but as a whole, they still face a challenge in
meeting some of the estimates that we discuss in our
testimony----
Ms. Capps. I see.
Mr. Goebel. [continuing] because trading volumes have been
so high lately that they'll just continue to go up further.
Ms. Capps. Does an investor perceive this, or what's their
reaction, then--the public?
Mr. Goebel. It's probably not something that investors are
individually aware of unless they experience just slowness in
getting an order executed.
Ms. Capps. I see.
Mr. Goebel. So it's sort of that behind-the-scenes effect.
Ms. Capps. Okay. So it's being handled, at least to a
degree that you feel somewhat comfortable with. Of course, this
is the current status, not what we're anticipating?
Mr. Goebel. Yes, I mean, I guess as Davi pointed out, we
know they're taking steps, but there still remains a gap in
meeting the kinds of projections that are expected to arise in
the next couple of years.
Ms. Capps. And then one sort of related issue which is
troubling to me is the fact that Nasdaq will not be
participating in the first two industry-wide tests, which are
scheduled I believe for April and May, and that they haven't
factored into their planning the increased estimates from SRI.
Are you concerned about this and is one test run in June going
to be enough for this huge issue with Nasdaq in your opinion?
Ms. D'Agostino. That's a very good question. We haven't
even thought about whether or not one test would be adequate.
But we can say that actually the June test date was added for
the Nasdaq because it wouldn't be able to make the two that
were originally scheduled. And actually over the period of
doing this work we were initially very highly concerned about
the risk posed to the options, and now in recent weeks with
what we've learned about Nasdaq's capacity and their plans,
we're more concerned about the Nasdaq----
Ms. Capps. Well, what happened----
Ms. D'Agostino. [continuing] for the longer hall without
taking some serious due diligence and action to enhance their
capacity.
Ms. Capps. Yes, well, have you developed scenarios for a
response, say, should the test not be what you want to see in
June? I mean, the results could be all over the map, right?
Ms. D'Agostino. They could be.
Mr. Goebel. It might be worth pointing out that the tests
that the industry has designed, the three tests that Nasdaq
will participate in the June one are essentially designed to
test the processing changes, can they actually accurately trade
in decimals, and they don't include a capacity element. So it's
very expected that the processing changes that the exchanges
and Nasdaq have made will likely work out. They're going to run
scripted trades and things to make sure that the messages that
are appropriate to send come back and forth.
The testing of capacity will more or less come out of the
pilot that they run during the second phase of implementation
where they're going to take a selection of hopefully
representative securities--stocks and options--and see how they
actually trade, what kind of volumes are experienced in those
securities during that pilot, and that will really give them
some indication of the actual impact of decimals on capacities
of systems.
Ms. Capps. I guess I would say, I hope we can stay in touch
with you on this issue.
Mr. Oxley. They're our lifeline, we'll keep communication
open.
Ms. Capps. Thank you very much.
Mr. Oxley. The gentle lady's time is expired.
The gentleman from Illinois, Mr. Shimkus.
Mr. Shimkus. Thank you, Mr. Chairman. Mr. Chairman, I would
like to yield back my time and listen to the next question if
someone else has one before I ask.
Mr. Oxley. Okay. I owe you one.
Mr. Shimkus. You owe me more than one.
Mr. Oxley. The gentleman from New York, Mr. Engel.
Mr. Engel. Thank you, Mr. Chairman. I too have a lot of
trepidation about this. In fact, when the committee was first
looking at this, I was cautioning and saying, why do we not let
the market regulate itself. And then I said I thought I sounded
too much like a republican.
Mr. Oxley. Fat chance.
Mr. Engel. Don't worry, Mr. Chairman, you were at the stock
exchange that is week, but I was there a few hours after you,
so I got the full report.
We know that the timeframe is troubling. I wish you would
just talk about that a little bit. The questions here have
been--people have asked about the increase in trade and
quotation traffic, there's a fear that the computer capability
won't be able to cope with it. I thought we were rushing into
this, can you just talk a little bit about what you've seen and
your impressions of the computer capability and the timeframe
and some of the fears that you mention in this report? Wouldn't
we be better off to just kind of slow this down a little bit?
Ms. D'Agostino. Well, I think that industry is putting
together a plan that is very well thought out and involves
phasing in to allow for time to the members who aren't ready to
catch up. But it will require them to due diligence and upgrade
the systems that need upgrading to meet the scheduled date.
It's not clear that adding more months to the schedule is
necessarily going to solve the capacity issue. What will solve
the capacity issue is investing in capacity upgrades.
Mr. Engel. Well, for instance, the question Ms. Capps asked
about Nasdaq, you answered Nasdaq couldn't make the first two,
so----
Ms. D'Agostino. Right.
Mr. Engel. [continuing] really only having one, and you
were unsure about whether or not that would be adequate. If we
had more time and perhaps there could be more than one,
wouldn't that just be better.
Ms. D'Agostino. Yes, they certainly could schedule
additional tests including capacity tests which was an idea
that we sort of shared amongst ourselves, but didn't fully
develop to be honest with you. Even during the phase-in period
to March 2001. There are a lot of things that can be done
concurrently during this schedule and since the participants
seem to have differing states of readiness in terms of
capacity, I mean, that's really incumbent on them to bring
themselves up to speed for the schedule.
Mr. Engel. Let me ask you this, a public/private
partnership was created between the Securities Industry
Association and the Securities and Exchange Commission to help
implement the conversion to decimals. Can you comment on how
that partnership has been functioning as we're moving toward
implementation?
Ms. D'Agostino. SEC has been monitoring and even maybe
participating in a lot of the SIA--well, actually all of the
SIA committee meetings. They've been helpful, like, for
example, in the SRI study. They provided assistance in that
regard. They've really been staying on top of this and I think
working closely with all of the players to try to make sure the
solutions that they come to are collaborative as opposed to
directive from the SEC to the industry.
Mr. Goebel. It's probably worth pointing out that the SRI
gained a lot of experience from spearheading the year 2000
efforts for the industry because it was one of the things that
definitely affected every participant in the securities markets
and they established a committee structure and timeframes and
testing schedules that obviously worked very well for Y2K.
They've in essence transferred that sort of thinking and
infrastructure to the decimals issue and it seems to have
helped it move along as fast as it has. And SEC has been
working and interacting with all these players throughout. So,
it appears to be successful.
Mr. Engel. If you see the testimony and some of the
trepidation that some of us had in previous committee hearings
it was the Y2K problem was foremost in our minds in terms of
worrying about that, and on top of that worrying about
decimalization. Obviously we still have a long way to go.
I want to also thank the Chairman for these hearings and I
look forward to continuing to ask these questions because, you
know, again, we do have concerns. Obviously I represent New
York and it's a very important industry to our City, and to our
State and the country, and I just worry that we may be rushing
too quickly into this.
Mr. Towns. Would the gentleman yield?
Mr. Engel. Yes, I would certainly yield.
Mr. Towns. I would like to associate myself with that part
of your question.
Mr. Oxley. I would say to my good friends from New York, I
think it's probably in the water up there that you're nervous
about anything anyway. And we'll deal with that as time goes
by.
The gentleman from Maryland.
Mr. Ehrlich. I apologize for the lateness--my lateness. I
am particularly interested in cost conversion compared to
investor savings, projections, numbers, I'm sure you all have
talked about this, but for my edification, with apologies to
room, could I hear a quick synopsis with respect to that issue?
Ms. D'Agostino. Are you asking--I just want to clarify, are
you asking what this effort is going to cost the industry----
Mr. Ehrlich. Yes.
Ms. D'Agostino. [continuing] versus what the expected
savings to investors?
Mr. Ehrlich. Yes, ma'am.
Ms. D'Agostino. Okay. Basically the only cost estimates
we've seen is a final draft study by the Tower Group that was
done for the SIA, and they estimate that decimals will cost the
industry $907 million--I'm sorry, yes, million dollars. And
it's a one-time cost.
Mr. Ehrlich. Right.
Ms. D'Agostino. Some of the studies that we've seen, and
they have a range of estimates going from $300 million up to $2
plus billion and there are a lot of, you know, questions about
some of those estimates. But in any case, these are annual
savings expected to accrue to investors from moving to
decimals.
So it's a one-time sunk cost of $907 million against annual
savings of anywhere from $300 million to $2 plus billion.
Mr. Ehrlich. On the savings side, what accounts for the
wild disparities in the numbers?
Ms. D'Agostino. They include and exclude various factors.
For example, some of the studies might not be accounting for
the fact that a lot of trades aren't made on spreads and
various other things. But that's basically----
Mr. Ehrlich. Thank you. I yield back, Mr. Chairman.
Mr. Oxley. The gentleman yields back.
The gentleman from Minnesota, Mr. Luther.
Mr. Luther. Thank you, Mr. Chairman. Just one quick
question. One of the areas where there's been some concern on
behalf of consumers is this whole area of principal trades
where underwriters are making markets themselves and the
profits that are involved in that. How will this impact? What
impact will this have in that area of principal trades?
Mr. Goebel. In our previous testimony last year, we did
speak with all the folks we tried to talk to about the impact
on dealers and we also tried to look at what impact it had had
on dealers and principal traders in the other markets. And I
think what came out of that was that it was a mixed effect. As
spreads decline, they may actually make less in trading
profits, but there are generally more trades that occur and the
data that was available at that time showed that it was a
neutral impact on trading profits. For example, in Toronto,
there was no change in the profits of the dealers. Some of the
other work we did found that some market makers withdrew from
making markets and securities for economic reasons, but Nasdaq
reported to us after the moving sixteenths that reduced spread
similarly, additional market makers entered the market and they
saw no net effect as a result. So it seems to be a mixed
unclear impact.
Mr. Luther. Yield back.
Mr. Oxley. The gentleman yields back. The Chair is now
pleased to recognize one of the leaders in this effort and
another nervous New Yorker, a gentleman from Staten Island.
Mr. Fossella. I'm calm, Mr. Chairman.
Thank you, Mr. Chairman, I'll be very brief. I know there's
been a lot of attention on the options market and there seems
to be a sort of geometric problem associated with the increase
in the number, at least in capacity, but what about the
equities markets, No. 1; to what degree is there a problem
there? And second, there seems to be a level of concern with
the current conversion to decimal trading, at least as the time
tables allow the number of--do you have any other suggestions
or solutions to address that concern that you've raised, and
others here have raised?
Ms. D'Agostino. I guess, let me start with the first part
of your question. And how are the equities markets bearing or
how do they look right now at this snapshot? Right now the New
York Stock Exchange, for example, appears to be less of a risk
toward successfully handling decimals trading by 2001 based on
the SRI projections. But the Nasdaq, on the other hand, does
not pose such a low risk. The updated estimates from the SRI
projections have caused additional concern on the part of the
Nasdaq based on our discussions just 2 days ago. So that's
where we think we see some risk on being able to handle the
capacity demands posed by this move.
But, again, I think we also said earlier that they're
having trouble processing their current demands without decimal
trading. So, there are things that the Nasdaq are going to have
to do to ready itself for decimals and also prepare itself for
the increased volumes they're likely to experience in the
coming months without decimals.
Mr. Fossella. Thanks. But, if I may, there is a timetable
set for the conversion to decimals. There seems to be a risk
associated with that. I don't know to what degree you're posing
there's a risk. Are there any--if you had your druthers at this
point, what would you recommend with respect to the current
conversion to decimals timetable?
Ms. D'Agostino. We don't have any issues with the current
timetable. To be honest with you, I think it was set jointly
with the industry. I mean, the industry basically came up with
this timetable. And to the extent that different market
participants are at different states of readiness, I think that
the schedule should suggest to the participants what they need
to do in the coming months to ready themselves.
Mr. Fossella. Is that possible? Can everybody step up to
the plate in your estimate? In your opinion can everybody step
up to the plate given the current timetable?
Mr. Goebel. The timetable that we reflect in the chart is
already a different timetable than just several months ago.
Originally some of the later phases were going to start as soon
as October for unrestricted trading in decimals. So there's
already been an adjustment and some additional time added
because of the developing capacity concerns particularly on the
Nasdaq which is, you know, setting record volumes almost daily.
The schedule also embodies various points where they're
going to be assessing what's going on after the initial trading
in nickels, the pilot for pennies will also provide data that
will allow the SEC and the industry participants to formulate
the plan for the next step, I think. And in January they're--
the SEC order directs the markets to either jointly submit a
proposal for what the MPV should be for the market, or allow
the individual exchanges to set that. But I'm sure they'll take
that into account with what their capacities are at that point.
Mr. Fossella. I'll conclude, Mr. Chairman, thank you.
Mr. Oxley. The gentleman yields back.
Mr. Shimkus. Mr. Chairman, if I may?
Mr. Oxley. The gentleman from Illinois.
Mr. Shimkus. Just briefly. I'm really excited about this. I
think that the players who might be lagging behind had better
catch up or they'll lose their business base. I am excited
about these projections of increase, I'm excited about the
smaller margin for the traders, and more involvement by the
consumer. But I understand the concerns, we want the system to
succeed and I can appreciate that.
The only question I have is--and I apologize too, I was in
a meeting up here. Mr. Rhodes' name is not on this witness
list, can you tell me who are you representing and why are you
at this table?
Mr. Rhodes. I'm with the General Accounting Office.
Mr. Shimkus. Okay. You're just----
Mr. Rhodes. I'm their chief scientist.
Mr. Shimkus. Okay. Thank you very much. That's all I have,
Mr. Chairman.
Mr. Oxley. Thank you. And the gentleman yields back.
Let me indicate to the members that this is an historic
occasion in that the markets are going to decimals. We will now
join the rest of the world in decimals, in large part because
of what this committee was able to do, and we stand ready to
work with the GAO and with the SEC and all interested parties
to make certain that this transition, just like the transition
in the Y2K is seamless and reasonably painless.
I think the gentleman from Illinois pointed out some of the
real benefits here of going to decimals. Obviously the markets
at the end of the day will be able to handle this kind of
capacity and it will be of good news for them because that's a
lot of traffic and ultimately that's a lot of money. At the
same time the consumer is going to benefit by the narrower
spreads and by functionally illiterate people like myself who
don't understand fractions to better understand the market and
I think have more confidence in the marketplace as well. So at
the end of the day working with the SEC, with GAO, and with
everybody involved, I would say to my friends from New York,
that this will be a very historic occasion and one I think
we'll look back on with a great deal of pride in changing how
these markets work.
So we look forward to working with all of you and we will,
as I indicated earlier, have another hearing, at least one
other hearing as we move toward that July date of converting to
decimals for the first time in our history.
The Chair would ask unanimous consent that all members'
opening statements be made part of the record, and so ordered.
And with that, the committee stands adjourned.
[Whereupon, at 10:58 a.m., the subcommittee was adjourned.]
[Additional material submitted for the record follows:]
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