The Changing Face of Market Electronification

Terry Flanagan

As the capital markets continue to become more and more electronic, market participants assert that the sweeping changes have had dramatic effects.

The alterations have had a particularly substantial impact on the foreign exchange market, according to Sanjay Madgavkar, global head of retail FX trading at Citigroup, a bulge bracket bank.

“Among recent trends, the proliferation of technology has probably had the greatest impact,” Madgavkar told Markets Media. “For instance, as a result of the evolution of technology, market makers have developed sophisticated algorithmic price making capabilities. The battle for latency reduction, which is well known in equities trading, has also become an important factor in FX electronic execution. Technology has also allowed providers to handle hundreds of thousands of tickets via efficient post-trade transaction processing. Overall, it’s fair to say the FX market is unrecognizable today compared to where it was a few years ago thanks to technological advances.”

Tom Joyce, chief executive of broker-dealer Knight Capital Group, speaking at Markets Media’s Electronic Fixed Income Trading conference in New York earlier this month, noted that foreign exchange is positioned between equities and bonds, and as such the trajectory of the FX market structure can provide a good blueprint for how bond trading will evolve. Algorithmic and high-speed trading are making inroads in FX and could be headed for the bond market as well, he said.

The foreign exchange market was said to be the first asset class to adopt electronic trading decades ago, on the interbank market. Equities, options and futures followed and now bonds are set to follow. But the adaptation has been slow, particularly because the bond market is so varied, with some instruments highly liquid, while others trade a handful of times per month.

Market technology has once again been thrust into the spotlight following the issues surrounding the Facebook initial public offering. Knight Capital and hedge fund Citadel, both of which are also market makers, revealed that they each could suffer losses of up to $35 million because of technical problems on Nasdaq OMX related to the IPO launch on May 18.

Nasdaq rival NYSE Euronext will be keen to use the incident to champion the need for a human element in the markets, as it is one of very few remaining exchanges in the U.S. to retain an open-outcry trading floor.

The Facebook gaffe at Nasdaq came months after Bats Global Markets, the third largest exchange operator by market share in the U.S., had a critical error on its own IPO, which was to be listed on its own exchange. Once again, it was technology that was blamed for the issues, which were substantial enough for Bats to pull its listing off the table indefinitely.

However, despite the occasional problems that arise from overstrained technology, some say the positives have far outweighed the negatives.

“Many people fail to see the efficiencies created by electronic trading,” Keith Ross, chief executive of PDQ Enterprises, an equity trading venue, told Markets Media. “We used to have eighth and quarter spreads, now they are tenths and pennies. It used to take five to 10 minutes to fill orders, now it’s in milliseconds.”

PDQ operates an alternative trading system geared towards high-speed electronic traders.

Despite the new efficiencies and capabilities that are now present in the markets, not everyone sees full electronification as the future.

The International Securities Exchange plans to start a new exchange, the second for the company, later this year. The junior options market is expected to utilize a hybrid electronic and open-outcry floor trading model, bucking the overarching trend in recent years for exchanges to scrap their trading floors entirely. However, ISE chief executive Gary Katz has said the floor would be unlike any other existing trading pit, and would reflect the technological advancements of the modern markets.

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