Technology’s Pervasiveness Yielding Exchange Consolidation, Alternative Execution

Up until very recently, technology has helped strengthen the position of these players. But now technology itself is what is making the position of traditional players untenable.

It is not a big surprise that low-latency market data and automated trading are the talk of the town. It is, in fact, a natural evolutionary step for financial markets. Trading technology has been at the forefront of technology adoption since the beginning of the last decade.

However, never before in the history of the financial markets has technology played such a central role. Business models are not only being impacted by technology but are developed using technology as a building block. Algorithmic/automated trading and dark pools are nothing but the latest manifestations.

Technology and its pervasiveness (as determined by processing speed and network bandwidth) are making life a bit more challenging for a group of players that has so far made use of physical accessibility as the only means to enter the game. Up until very recently, technology has helped strengthen the position of these players. But now technology itself is what is making the position of traditional players untenable.

We are currently witnessing two market trends as direct consequences to technology pervasiveness: exchange consolidation and the emergence of alternative execution venues. These two trends are what pundits will call liberalization of the markets, but the reality is that these trends are injecting much sought-after efficiency, hence propelling the biggest margin squeeze in the history of the industry.

It is not enough that technology is forcing traditional players to evolve; it is also being tapped (and this is the beauty of it all) to counter its own effects and as such, is bringing the whole business into a new realm. After all, just like any other business, you've got to have a value proposition to stay in the game.

This value proposition is nothing but a combination of speed and anonymity. Speed in determining what to trade, when to trade and where to trade is now hailed as the holy grail of the trading profession. Information pervasiveness as well as volume make it next to impossible for humans alone to capture, digest and act on data before it becomes obsolete.

Computer-initiated and assisted (automated) trading is technology's answer to this new paradigm of speed. Traders are just like car fanatics when it comes to speed. Both always want the latest and the greatest, and this means — in the case of cars, trades and data — the fastest. Exchanges are rushing to offer faster execution and faster data services in the hope that this will improve their value proposition and help them retain liquidity. Technology vendors are riding this new wave of thirst for speed with better software and hardware. In the midst of this environment, traders are assessing how much speed — and, in the same spirit, anonymity — is necessary to stay ahead of the competition.

But the speed value proposition is a transient phenomenon, the likes of which we have seen being repeated over the last two decades. Technology pervasiveness will again play a countering role in this evolution, resulting in a complete erosion of the value proposition. Sooner than later, speed will become factored into the business model offering. Speed becomes an expected commodity rather than a selling feature.

However, the main-street version of speed will be a watered-down, commoditized derivation. The analogy Celent draws on is bringing fast cars to the masses at an affordable price despite the fact that not all drivers are race car drivers able to make good use of this speed. For the majority of the traders who are asking for more speed, a point will be reached beyond which more speed is hard to justify. Only a select few have the skills and the deep pockets to venture further in harnessing the advantages of speed.

The competitive edge of the trader will be derived from his/her ability to apply skills such as creativity, innovation and relationship-building effectively in a highly automated trading environment. It is much like an airline pilot getting used to flying a new plane packed with gadgets and dials designed to make flying the plane more effective. In fact, the user of this new automated trading environment will be much more powerful than an airline pilot since he/she has the ability to adjust the flight plan dynamically and in real time.

Who is preparing for this new reality? Likely only a handful of firms. In fact, there are not enough race car drivers out there. This is where the future lies.