When the International Stock Exchange announced its birth in 1999, the options community barely batted an eye. But once the all-electronic Eurex established itself as the biggest futures exchange in the world, signaling the coming-of-age of electronic trading, options exchanges scrambled to come up with a plan to stay relevant in the new trading era.

U.S. options exchanges had been protected from external competition for years as a result of a gentleman's agreement not to list each other's contracts. But the ISE threat quickly changed that, and the Chicago Board Options Exchange last fall fired the opening salvo in what quickly became a nasty listings war. Soon, the exchanges were listing their competitors' most popular contracts—all with an eye on the ISE, which promised to list options on 600 top equities.

The maxim that increased competition benefits customers didn't always hold true in the new options markets. Customers without floor operations on all exchanges frequently found that they weren't getting their orders executed at the best possible price.

Happily for customers, that situation won't last forever. Last October, the Securities Exchange Commission ordered the CBOE, American Stock Exchange, Philadelphia Stock Exchange and Pacific Exchange to come up with a plan to link electronically with one another in 90 days. In January, the four submitted their plans, but, as expected, the exchanges hadn't reached an agreement on the appropriate course to take. Now, the SEC must weigh the plans and come up with a solution.

The CBOE and Amex submitted identical plans separately, but the PHLX and the Pacific Exchange each submitted its own plan. The ISE, not asked to participate, nevertheless filed a letter supporting the CBOE-Amex plan. No wonder—the plan decidedly favors those three exchanges, and, if implemented, could hasten the demise of the others.

The most critical differences in the plans: the CBOE-Amex-ISE plan would allow their members to match the best price on an option—meaning that those exchanges would enjoy an equal crack at contracts that trade less robustly there. The PHLX and Pacific Exchange, meanwhile, both submitted proposals that would see trades automatically routed to the first exchange to post the best price—a clear attempt to protect their liquidity.

The SEC wasn't thrilled with the disunity. "In the next few weeks,” said chairman Arthur Levitt, "we will carefully consider all aspects of these linkage plans and then publish the plans for comment. We will not let differences among the options exchanges stand in the way of this historic opportunity to achieve a truly national options market. Options investors have waited far too long for a market with the most vigorous competition possible.”

Meanwhile, the SEC has another issue on its plate: the ISE, which the regulator has still not cleared to begin trading. The ISE had been planning to go live after the expiration of the March contracts, but at press time no SEC approval had been granted.

The ISE was "cautiously optimistic” that the SEC would give it the green light, but admitted that a few details had to be ironed out. Once approved, the ISE will initially list just 30 options in the middle of the liquidity pack—not the high fliers but not the dogs either—to allow customers to get their feet wet. At press time the exchange hadn't announced which contracts would be listed first.

Greenspan Turns Up Heat

Last month, Federal Reserve chairman Alan Greenspan, in a hearing before the Senate Agriculture Committee to discuss the President's Working Group report on over-the-counter derivatives, strongly pressed Congress to exempt OTC derivatives from the regulatory scrutiny of the Commodity Futures Trading Commission when it reauthorizes the CFTC later this year. "Over-the-counter derivatives have come to play an exceptionally important role in our financial system and our economy,” said Greenspan. "These instruments allow users to unbundle risks and allocate them to the investors most willing and able to assume them. The legal uncertainties create risks to counterparties in OTC contracts, and indeed, to our financial system, that are simply unacceptable. They have also impeded initiatives to centralize the trading and clearing of OTC contracts, developments that have the potential to increase efficiency and reduce risks in OTC transactions.” "I see a real risk,” he argued, "that, if we fail to rationalize our regulation of centralized trading mechanisms for financial instruments, these markets and the related profits and employment opportunities will be lost to foreign jurisdictions that maintain the confidence of global investors without imposing so many regulatory constraints.”