A burning issue for exchanges currently is to look into their quality assurance strategies. There is a great need for reestablishing confidence in financial markets, and the foundation for this is reliable, well-functioning systems without frequent disturbances. Marketplaces’ matching systems used to be regarded in quality on a par with nuclear power plants; this approach needs to be regained.
It has become increasingly obvious that the technical infrastructure at major global marketplaces has fallen behind the remarkable innovation and developments in the trading community, and that quality is suffering. We’re seeing glitch after glitch, with trading repeatedly being halted due to technical issues, and several instances where uncontrolled algo trading has led to enormous losses.
“Just the kind of situations
that tend to excite regulators”
In general, marketplaces have invested too little in their technology over the last decade, which is remarkable, given the dramatic changes we have witnessed. During this period, markets have fragmented, and high frequency trading has gone from zero to being a substantial part of the total market. Market participants have changed their behavior, their trading patterns and their systems. Yet the IT infrastructure in the biggest marketplaces looks much the same as it did in 2008. This creates vulnerabilities and unacceptable risks, repeatedly disturbs trading and contributes to a crisis of confidence for the industry as a whole. Just the kind of situations that tend to excite regulators.
This has created a renewed interest in exchange system quality. There is a pressure from regulators and market participants, and we now see exchanges starting to seriously invest in trading systems again. It lies very much in the industry’s own interest to build reliable systems that ensure stable trading, if regulators are not to intervene.
How can the markets come to terms with inadequate system quality? The recent events demonstrate that the time for building systems in-house is long gone.
“Many of the electronic markets have matured
and become increasingly standardized”
Okay, I take the risk of coming out as biased in this matter, being CEO of a software company. But the fact is no one has a market model today that is so special that they can’t use a reasonably flexible third-party trading platform. As many of the electronic markets have matured and become increasingly standardized, exchange systems have become commodities. This is partly driven by fierce competition between marketplaces; many offer the same products. To simplify for market participants to connect to and use your market, a well-known model and system is preferable. Here, the very successful industry standard protocol FIX has had a positive effect on market participants’ mobility and ease of connecting to new markets.
A big advantage of buying exchange technology from a specialized vendor is the rigorous assessments and audits constantly being carried out on their technology and processes. These companies are fully dependent on delivering well-functioning systems. They are specialists, and the incentives to deliver quality are direct. For an exchange to build and maintain its own system without such thorough scrutiny can be risky and costly. In the end, it becomes its market participants’ as well as its shareholders’ loss.
“The good thing about commodity goods is
that costs can be shared by many customers”
There are examples of start-up marketplaces that operate with their own systems successfully, with lean organizations. However, as the years roll on carrying the costs of constantly developing the system on your own will not only become a heavy burden. Exchanges that pursue this option will most likely not be in the forefront. The code base of a trading platform needs to be constantly renewed to stand up to ever-changing and tougher requirements. The good thing about commodity goods is that costs can be shared by many customers.
This is of course comparable to the evolution in other fields; nobody thinks about building their own accounting system today, but in the 70’s and 80’s that was standard.
The next step, which is gaining traction primarily among start-ups and new ventures within established entities, is to buy the core trading system as a fully managed service, enabling these players to focus their own resources on their core business.
I think an interesting question for the exchange boardrooms to explore is how to connect management bonuses to quality: reliability, system uptime and well-functioning, fair and orderly markets? This is probably a key to regaining trust for the financial markets, from the market participants, from regulators and from society as a whole.
Don’t hesitate to contact me if you have any questions or want to discuss this topic further,
Veronica Augustsson, CEO of Cinnober