As rumors fly over potential takeover targets, there's no doubt that the global exchange scene is ripe for consolidation. Ever since the Nasdaq Stock Market purchased nearly 19 percent of the London Stock Exchange's (LSE) shares in April and May, the U.S. suitor has raised the ante for other exchanges, including the NYSE Group, which operates the NYSE, to throw a hat into the ring. But while exchanges appear to be obsessed with gobbling up competitors, they should be more concerned with their technology. Specifically, is it equipped to handle the automated trading strategies of customers who have programmed their computers to search for miniscule price differences across global cash and derivatives markets?
Currently, Euronext.liffe - the derivatives arm of Euronext Group - is shifting its technology platform for Liffe Connect, its electronic trading system, to the Linux operating system/Intel-based processing architecture. It's also moving off of a Sun Microsystems mainframe that's running the Solaris operating system. By September, the European cross-border futures and options exchange, which operates five derivatives markets - London, Paris, Amsterdam, Brussels and Lisbon - will have replaced the guts of its matching engine with an Intel/Linux platform, an unconventional move that would have been unheard of a few years ago. The main reason for the switch is to keep up with the explosive growth of algorithmic trading.
According to Jim Johanek, SVP of U.S. Technology Strategy for Euronext.liffe, the volume has shifted to algorithmic trading and away from traditional point-and-click traders. "We need to accommodate this ever-sophisticated customer who is hitting our exchange through these automated trading tools," Johanek says. "Our customers were growing in number, but the [Intel architecture] technology they were using was advancing faster than our own." If the exchange remained on older technology, it would play a game of catch-up with the algorithmic traders, he admits.
There have been more advances on the Intel platform than other brands, contends Johanek, because of all the R&D that has gone into it, coupled with the sheer number of systems. And now, with algorithmic trading, Euronext.liffe is dealing with traders who operate multiple models at one time. Of course, cost is another factor. "The (Lintel) technology is 30 times less expensive for the same amount of performance," asserts Johanek. Now that many of these exchanges are publicly traded, they are under pressure to generate revenues, and that growth hinges on making markets in more instruments and processing more orders.
In a commentary on Nasdaq's strategic investment in the LSE, Harrell Smith, manager of the securities and investments practice at Celent, contends that an acquisition by Nasdaq would make "much more sense than an NYSE investment." The analyst notes that the NYSE is still grappling with the integration of its Arca platform and the rollout of the Hybrid Market. "Should Nasdaq ever take a controlling interest in LSE, the technology synergies between the two exchanges would be much greater than they would between NYSE and LSE," writes Smith.
Meanwhile, with the escalating complexity of supporting algorithmic trades and real-time order book feeds, exchanges are faced with the challenge of how to keep their own technology simple. "[ECNs] took cash equities and ran on technology that was very simple, and, as a result, they reached high throughput," points out Johanek. One reason Nasdaq is in a good position is that it has consolidated all of its electronic liquidity pools (Brut, Island, Inet and Supermontage) onto a single platform - INET.
So as exchanges scout for new combinations, technology should be at the heart of these potential merger decisions. Otherwise, the cost and complexity of supporting multiple markets could get out of hand and algorithmic traders, always on the prowl for fast electronic markets, could go elsewhere.
Ivy Schmerken is a 20-year WS&T veteran. As Editor-at-Large, she covers trading for both Wall Street & Technology and Advanced Trading. [email protected]Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio