With High-Frequency Trading, Financial Firms Face New Challenges
In recent years, the financial industry has witnessed a revolution. To discuss, debate, and seek a bit of consensus on the crucial issues impacting the industry, I met earlier this year in New York with a team of experts at the Electronic Trading Innovation Council. For the event, Cisco partnered with the founders of the council, Julio Gomez and Clay Booma. I was joined by my Cisco colleagues Aron Dutta, co-managing director for financial markets, Cisco IBSG; Chris O’Connell, Cisco’s head of strategy for alternative investment markets; and Dave Malik, Cisco’s technology & architecture lead. The other participants represented a wide range of financial and tech-based firms, including BNY Mellon, Citi, Credit Suisse, Lazard Freres, Morgan Stanley, Nomura, State Street, UBS, Equinix, Savvis, and Tervela.
It was a great team, and the roundtable meetings benefited from a vast body of knowledge and a high level of participation.
Three main points of discussion emerged:
- Defining High-Frequency Trading: How is this defined and what role should government (regulation) play? Is the issue the automation of trading by computer, or is it position and execution management? If I buy and sell a position in five milliseconds, is that high-frequency trading? What if I sell in seven milliseconds, or for that matter, two hours or two weeks. At what point does the government feel it can regulate trading strategies and activities, and what impact does it have for our capital markets on both the client and proprietary side of trading? These questions drove a spirited debate. And while there was no final consensus among the participants on how to fully define a high-frequency trade, there was clear agreement on the need to find a consensus. Since it is not clarified in regulations like Dodd-Frank, the industry needs to agree on its own definition, along with other measures to deal with emerging regulatory burdens.
- Fragmentation of Liquidity: The “hunt for liquidity” is at the center of the recent market reconfiguration. In the old days, this meant stock exchanges located in just a few financial centers—geographic locations with asset class specialties and a known membership of participants. Today, technology allows transactions to occur virtually any “place” where buyers and sellers can meet electronically. These alternative trading venues feature additional pools of liquidity (e.g., dark pools) that are offered and executed outside of a traditional exchange. One problem, however, is the growing expense of maintaining access and transparency through all that fragmentation. Connecting to all those disparate centers makes it very difficult for any one buyer to see whether he or she is getting a good deal. But the group agreed on an eventual solution: an overarching, network-based liquidity center. This would be cloud-based and capable of aggregating thousands of liquidity centers into one logical, buying-and-selling marketplace, assuring transparency. As Julio Gomez put it, tech trumps fragmentation.
- The Commoditization of Transactions: The more people know about what’s for sale, the less you can charge for making the transaction possible. After all, a higher price comes with information that no one else has. But with a more transparent, unified market, customers will know exactly what’s for sale. Which leads to another trading challenge: commoditization of trading. This is creating a conflict in the industry: Do we want an efficient marketplace with low costs per transaction, or an inefficient marketplace with high cost per transaction? Regardless, the group discussed how some industry players—including exchanges (for example, NYSE, Chicago Mercantile Exchange, and Direct Edge) and market participants (buy-side and sell-side)—are examining ways to branch out from their core role: seeking new revenue streams by offering technology services, distributing market data content, providing order management execution services, or offering pre-trade analytics services.
Ideally, I would like to see the Electronic Trading Innovation Council convene three times a year, with an open invitation to expand its level of participation and base of knowledge. The industry can only benefit from the brainstorming and strategies offered by this formidable collection of experts.