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Discussion in 'Retail Brokers' started by skerbitz, Apr 25, 2002.

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    Patent lawsuit may deal blow to e-trading
    Possibility of having to pay millions in royalties may delay wider use of computerised trading on exchanges

    By Dennis Chan

    A UNITED States court's decision to allow a company to claim broad ownership rights to the idea of computerised trading systems has sent a shock wave through exchanges.

    Going, going, gone? Not yet, it seems, for the vulnerable open outcry system. -- REUTERS
    It has raised the spectre of millions of dollars in royalties that derivative exchanges may have to pay the patent owner to implement or continue to use electronic platforms to execute trades.

    This complication may cause some of them, including Singapore, to delay replacing ''open outcry'' with electronic trading for all their products.

    The court has been hearing a lawsuit centred on the ''Wagner patent'' which has at its heart a simple idea: the computerised matching of bids and offers on an electronic platform.

    It covers the electronic trading of any futures contract in the US, including interest rate, commodity and single stock.

    The idea behind the patent is so basic that few people thought that it could be claimed as an original invention.

    The first-come, first-served order-driven system prescribed in the patent is employed by many stock and futures exchanges, including the Singapore Exchange (SGX), without them having realised that it may be the subject of a patent.

    Not only can the idea be patented as intellectual property rights, but also the scope of the patent should be interpreted broadly. The latter was decided by a US court last year.

    While the case is far from being concluded, that preliminary ruling, market-watchers said, will hamper the migration from the open outcry system - in which brokers shout and use hand signals to transact trades - to the electronic platform.

    This is because the exchanges which make the move may have to pay massive amounts in licensing royalties.

    A licensing deal signed earlier this month between Internet-based Intercontinental Exchange (ICE) and the current owner of the patent, eSpeed, saw ICE agreeing to pay a minimum of US$2 million (S$3.7 million) a year plus 10 US cents per contract or 20 US cents per contract for matched trades - whichever is higher - until 2007 when the patent expires.

    Given the large numbers of contracts that are transacted each day by top derivatives exchanges, the royalties for use of the electronic trading system could add up to a big amount, say industry-watchers.

    Take the example of the Chicago Mercantile Exchange (CME).

    A total of 81.9 million contracts were transacted through electronic means last year, accounting for 19.9 per cent of its total trading volume.

    Based on those figures, it would have to pay royalties estimated at US$18 million.

    In fact, CME has already warned of the adverse impact which the Wagner litigation would have on its business, financial condition and operating results, ''including our ability to offer electronic trading in the future''.

    The patent application dates back to 1983 and was filed by the idea's inventor, Ms Susan Wagner, a former executive director at the Commodity Futures Trading Commission.

    After a long battle, the patent was recognised finally in 1987.

    To enforce it, a later patent owner - Electronic Trading Systems - sued the CME, the Chicago Board Of Trade, Nymex and Cantor Fitzgerald for infringements in their electronic systems.

    Cantor settled the suit for an undisclosed consideration.

    Later, its affiliate eSpeed bought the patent rights and took over as plaintiffs in the remaining suits against the other three exchanges.

    eSpeed has not indicated whether it intends to go after foreign exchanges.

    When asked how it might be affected, the SGX declined to comment specifically on the patent but it reiterated that it ''will maintain the open outcry trading system as long as there is a demand for it''.

    ''The exchange has previously mentioned that new derivatives contracts will be listed on its electronic trading platform unless there is specific market justification for it to be traded in the open outcry.''