In accordance with agreements reached at the time of its inauguration in 1994, the Trading System Amsterdam (TSA) has been the subject of a thorough evaluation over the past year. Interviews have been held with investors and intermediaries, the spread and depth of the market in Amsterdam were compared with various other exchange and two advisory bodies to Amsterdam Exchanges, in which users of the trading system are represented, were invited to give their views on the functioning of TSA and to submit recommended changes to the management of Amsterdam Exchanges.

The management of Amsterdam Exchanges has published a discussion article detailing their preliminary standpoint. In the paper management explains the measures it intends to take. Unless otherwise stated, all measures relate only to trading in the most liquid, or limit book, stocks.

Amsterdam Exchanges expects to reach a final decision on the new TSA system following a round of discussions at the end of December. The main elements of the discussion paper are summarised below.

Summary

1. Amsterdam Exchanges is of the opinion that the trading system for the markets it operates should give users the opportunities to trade at the best possible price, and as cheaply as possible. The extent to which this objective can be realised and the specific market regulation that it will require are dependent on the type of product that is traded (shares, bonds, options, futures).

2. An order-driven market, in which orders from the market users are brought together, is in principle the most efficient market organisation. Such a market is not however adequate in all circumstances and sometimes has shortcomings in the areas of price formation and immediacy. Where these shortcomings are manifest, it is the role of the professional parties to supplement the order-driven market.

Because of the involvement of these professional parties means additional costs for market users, their contribution to price formation and liquidity must carry enough added value to justify the cost. The price paid for the services must be in line with their added value.

3. Amsterdam Exchanges believes that where possible the share trading system should be order-driven. For an optimal functioning, a centralised order flow, ie a central market, is needed. In order to achieve a concentration of liquidity at a single point - the Limit Book - market fragmentation should be avoided and ASSET and AIDA abandoned. This will require a number of changes in the Limit Book. Specifically, it would mean making it possible to place orders anonymously in the Limit Book and taking various fee mearures.

4. The publication of the depth of the market in the Limit Book is an important step in achieving this objective as a means of meeting the demand for pre-trade information once ASSET has been abolished.

5. Although the retail obligation is a useful instrument in bringing about the centralisation of the order flow, it is Amsterdam Exchanges' view that use of the central market should be left to the market mechanism. The central market should be made so attractive that it proves its own economic usefulness, and using the central market therefore becomes preferable to other execution methods. On the other hand, the need for investor protection means that secure regulation is required to ensure that, in principle, orders from private investors will be filled at the best price and that the best price can be achieved on the regulated, central market. Of course, the private investor must also be able to have orders filled elsewhere, for example via admitted institutions of Amsterdam Exchanges, although this must always be done on the basis of the best execution rule. Amsterdam Exchanges hopes to accomplish these objectives by amending the retail obligation.

Ideally, the rule should be that orders from private investors will be filled on the AEX-Effectenbeurs unless otherwise agreed with the client or where this best serves the client's interests. If orders are executed in another manner, Amsterdam Exchanges will set no additional requirements, provided that the order is filled on another regulated market of FIBV exchange. If the broker himself wishes to act as the counterparty, or wants to match the order in-house, the order should be executed at a price within the Limit Book's BPR. Efficiently monitoring compliance with this rule would mean making it compulsory to cross the order via the Limit Book. For institutional investors, there is no need to provide additional price protection via crossing in the Limit Book.

To put this rule into practice, each client should be categorised as private or institutional; this type of division is very common in other countries. Amsterdam Exchanges will to discuss categorisation with the STE.

Pending this discussion, Amsterdam Exchanges prefers for the time being not to link the above provisions to an investor category, but to the size of the transaction. As an interim solution, the principle of wholesale limits will therefore be preserved.

Once the categorisation of investors is a fact, wholesale limits can be abandoned or maintained pro forma at a lower level (eg f250,000).

Amsterdam Exchanges envisages a gradual transition to the new situation and at this point would therefore prefer not to set uniform wholesale limits of f250,000, but to continue along present lines, setting limits per stock, expressed in the number of shares. As a first step in the desired direction, Amsterdam Exchanges now sets wholesale limits in most stocks which are substantially lower than they were in the past. A gradual adjustment is preferable because it will give us the opportunity to discuss with the STE supplementary measures aimed at investor protection and is in line with the conviction that the central market is a valuable commodity and should as such be handled with great care.

6. Order-driven markets are not adequate in all situations. In exceptional circumstances, the order flow may be insufficient or one-sided; in certain stocks the order flow may be altogether insufficient, while the large transactions, an order-driven market is not always the most ideal method of execution.

In the opinion of Amsterdam Exchanges, human intermediaries have a part to play in by far the majority of stocks: to supplement and facilitate the functioning of the order-driven market. If the requirement can be met that the intermediary should be rewarded only for the added value he actually provides, there is no reason to deny him the opportunity to offer his services in certain stocks. Amsterdam Exchanges therefore advocates maintaining the hoekman in all stocks.

7. To prevent market fragmentation and avoid the risk of a reduced order flow from brokerage houses, Amsterdam Exchanges prefers a system in which there is one hoekman per stock.

8. Various measures are needed to meet the preconditions (payment based on added value) and to ensure that the hoekman only participates in trade where there is an actual need. Revising the remuneration structure is an important aspect of this.

9. In concrete terms, this means that the low brokerage fee will be abolished as soon as prior agreements with hoeklieden permit, ie 1 October 1998. As a first step in this direction, it has been agreed with the hoeklieden that with effect from 1 January 1998, orders can be placed free of charge. In Amsterdam Exchange's view, the high tariff can be preserved since the hoekman will still have a quote obligation.

10. Measures designed to ensure that the hoekman only participates in trading where there his services are needed are directed at the special privileges granted to him. The majority of these will be abolished. These measures relate to a knowledge of the identity of the person placing the order, the 15-second rule and freezing the order book at his own initiative. It will also be stipulated that the hoekman must fill (confidential) orders from brokerage firms by means of placing an order instead of using his quote.

11. Amsterdam Exchanges also intends to reallocate stocks periodically. This matter requires further research before a final standpoint can be adopted. At present, consideration is being given to a system in which Amsterdam Exchanges would enter into a contract with a hoekman for (packages) of stocks for a specific period of time (3,4 or 5 years). When the contract has expired Amsterdam Exchanges will carry our an evaluation, based primarily on the performance of the hoekman, to determine whether the package should be granted to the same hoekman for a subsequent period, or contracted to another interested party.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

For further information contact Raymond Salet, Amsterdam Exchanges AEX Amsterdam: 00 31 20 550 4433 or Paddy Manning, St James Corporate Communications London: 44 171 436 4101.