The battle for the soul of exchange-based equity trading?

The recent statements by Nasdaq regarding the possible use of a trading delay by the proposed IEX Exchange puts the spotlight on a battle for supremacy not just between rival exchanges, but very different philosophies regarding what the ultimate role of exchanges in the global capital markets should be. The established exchanges, willingly or unwillingly, represent the status quo in terms of how exchanges should function. IEX on the other hand hopes to represent the interests of those trading participants who believe that they have been left behind in the race for speed in today's capital markets, especially the retail participants and the smaller buyside. It seems like an inevitable outcome in the aftermath of the global financial crisis, which has stoked the debate on economic inequality and the unfair advantage that a select group of trading participants have over others due to their advanced technological capabilities and use of highly sophisticated financial products. 
Getting back to the objections raised by Nasdaq over the SEC proposal that any delay of less than a millisecond could qualify as immediate, which would enable IEX to operate in the way it wants, there is certainly some substance in Nasdaq's argument. The SEC would have to come up with a solution that is acceptable to both sides, and does not leave it vulnerable to legal challenges. It is going to be an interesting couple of months for industry obervers as they follow the debate over the fairness and validity of the SEC proposal, and the decision on the IEX application.

From the Celent Innovation Forum, Tokyo

At Celent we have been focusing on financial services technology since our inception. Now of course all eyes are focused on fintech, which we might inversely call the use of technology to disrupt (traditional) financial services. Investment in fintech startups is significant, and the financial markets involved are huge – US$218 trillion annually in the capital markets alone. Celent recently held our latest fintech event in Tokyo to a full house, an indication of the intense interest in fintech in the Japanese market. The day consisted of two Celent presentations on fintech in the retail and institutional securities industries, followed by a discussion panel. Celent senior analyst John Dwyer presented on blockchain technology and its potential use across capital markets. Smart contracts powered by this technology could conceivably replace existing means of executing market transactions, and by enabling direct ownership might displace custodians and other intermediaries. As if this weren’t food for thought enough, governments including the US and UK are taking a serious look at putting the dollar and the pound on blockchains. Talk about fundamental disruption! Senior analyst Will Trout provided an analysis of how automated advice (robo advisory) is reshaping the wealth management industry. After the financial crisis many individuals quite naturally want to manage their assets themselves, but also require investment advice. Robo advisory, which perfectly suits the self-service, mobile lifestyle, is an answer to this dilemma. SoftBank, Nomura Asset Management and The Bank of Tokyo-Mitsubishi UFJ joined the panel discussion, bringing their respective views on cognitive computing; the potential of fintech to lure Japan’s famously reticent retail segment to participate in the markets; and how to mobilize a large organization for innovation. A fundamental question about fintech is who will ultimately derive value from these innovations: fintech startups; technology giants like Alibaba and Google; or the incumbent financial institutions? Due partly to the regulatory stance, in Japan more than in most markets financial institutions may be in the best position to end up in the winner’s box. Only time will tell, for Japan and for markets across the globe, but you can rely on Celent to continue to provide our clients with insights in the rapidly developing world of fintech.

Launch of Luminex shows competitive market structure of US equities

The launch for trading this week of  Luminex is another example of the creative forces that come to light in the competitive and open market structure of US equities. Luminex will create an entirely dark, non-quoted, market protocol for real money buyside institutions. This has been described by some as as an exclusive club, but so what? The Luminex ATS is owned by a consortium of buy side firms: Blackrock, BNY Mellon, Capital Group, Fidelity, Invesco, J.P. Morgan Asset Management, MFS Investment Management, State Street Global Advisor, and T.Rowe Price.  The platform will begin trading this week with seventy three institutions with a minimum AUM threshold of 1 billion dollars. In aggregate, between the consortium owners and the other members of the ATS represent nearly 65% of US fund assets under management. The firm will be run as a not-for-profit with a low cost structure. The market protocol is completely dark, and non-quoted. Furthermore, it will run as entirely closed system, with no ability to route orders from within Luminex. The fabric of integrated venues-exchanges, ECNs, ATSs, internalization engines that make up the U.S. equity markets create an environment that offers tremendous choice for investors and traders of all stripes.  From the smallest retail clients, offered the key to this entire lattice at the cheapest and quickest executions ever through the wholesale market, to  the largest financial institutions, who can create a venue that meets their needs-moving natural size,  minimizing market impact and information leakage. Luminex is a powerful example of innovation in a market that fosters (perhaps forces) innovation. It will be an example of what a buy side consortium can create in an equity market with an already existing diverse means of accessing liquidity. Furthermore, it can set the tone, and structure for the evolution of other buy side consortia in asset classes with less diverse liquidity choices than US equities, and where access to liquidity remains an ongoing challenge, such as in fixed income. Whether another purely dark venue, with no incentivized intermediaries can gain noticeable market share, is always an open question. Low match rates are typical of a venue of this sort- but the users of the platform represent such a large chunk of assets under management and resident, natural liquidity is so great within the subscriber firms. It will be interesting to see the results of trading with this network and the market protocol.  

Equities trading in focus: radical cost restructuring is on the agenda

While our capital markets group has been focusing on derivatives and fixed income of late, due to regulatory and technology drivers, the businesses supporting equities markets continue to go through their own wrenching changes. With the equities business having persistently low revenue growth, stubbornly high costs, and capacity challenges, a new wave of thinking is required to get the business out of the mire. Until business improves, managers are no longer tolerant of high IT and operational costs. As a result, we have identified innovative strategies to reduce costs in the equities franchise for front office IT and operations. These strategies conveniently fit with how environmentalists approach their own questions of efficiency with resources, through the concepts of reduce, reuse, and recycle. Hey, it’s a slogan. Another slogan- We believe brokerage firms must think the unthinkable with respect to reducing costs through outsourcing. Some may consider this surprising since outsourcing infrastructure is viewed as a contrarian viewpoint, with infrastructure providing competitive advantage. But this is increasingly not the case. It is far better to assume that any and all IT can be outsourced than to assume none can be outsourced at all. This is the proper starting point, not the reverse. As a result, we expect more mid and top tier brokers to outsource more functions over time through the use of managed services, outsourcing, etc. The business is struggling with low margins and managers must make radical changes. Prime businesses and other derivatives trading are not enough to support an equities business that is very sluggish. For recommendations of how to proceed for brokerage firms, we recommend the latest report: Innovation in Focus: The Future of Cash Equities Trading Operations, which can be found here:

NasdaqOMX invests in TOM – not TOMS

Yesterday NasdaqOMX announced it was buying a 25% stake in The Order Machine (TOM), which has nothing to do with what most of you could think of: Bloomberg’s TOMS (Trade Order Management Solutions). Let me explain what TOM is. TOM Holding N.V. was founded in 2009 by BinckBank (independent online bank for investors listed on NYSE Euronext Amsterdam) and Optiver (a leading active proprietary trading firm in Europe) as a joint venture. In 2010 ABN AMRO Clearing Bank joined BinckBank and Optiver and became the third shareholder of TOM Holding. The fourth stakeholder was IMC financial markets (IMC – a leading proprietary trading and asset management firm in Europe) in 2012. TOM has been developed in the MiFID regulatory framework to provide a best execution service for retail investors. TOM has two main products: TOM Smart Execution which in essence is a Smart Order Router (SOR) that routes a bank or broker’s client orders to the best execution venue for its equities or equity derivatives orders, between Euronext, the TOM MTF and potentially other venues such as BATS Chi-X Europe. The other product is actually the TOM MTF (regulated trading venue under supervision of the Netherlands Authority for the Financial Markets), which facilitates open order-book trading in both cash equities and derivatives. It currently offers trading in Dutch, Belgian and French shares, and their derivative products. There is also trading in a  selection of ETFs.  Orders are matched in the TOM order-book based on price-time priority and is powered by NasdaqOMX technology for both equities and equity derivatives. TOM has roughly 15 per cent market share of the Dutch Equity Derivatives Market, Europe’s second-largest options market. In 2011 the SOR has processed 2,5 million of transactions with a turnover of EUR 21,8 billion. The MTF has matched 500 000 transactions representing EUR 3,5 billion turnover. A small but however interesting development for NasdaqOMX as it tries to make inroads into the European Derivatives Market. To be continued…

Innovations in OTC block equities: A new venue called Squawker

Squawker is a new venue based out of London for trading of OTC stocks (among other listed products like ETFs and warrants) focusing on the approximately 10-15% of equities that trade OTC in Europe according to AFME. Squawker (the title is based on the old squawk box) is not yet launched but what is most interesting is that it is focusing on an area that tends to be overlooked amidst all the focus on algorithmic trading/HFT where average trade sizes tend to be small and continue to decrease. Squawker focuses on institutional-size blocks between the sell-side and allows for IOI orders and FIX messaging plus private negotiation with minimum size. It is regulated under the FSA. The most interesting aspect is the ability to support the workflow of human interaction through electronic means- through instant messaging or chat technology which allows for exchange of details, negotiation, and matching. It is always a positive to see firms focusing on established markets (equities) in which technology is pervasive and numerous models thrive and support the market, but where there is a gap in the market (in this case block trades) and where greater efficiency can be created and liquidity can become easier to find by lowering search costs (i.e. electronic vs. voice).