Technology has contributed to a bang and a crash at
theLondon Stock Exchangeand created an
invisible world where billions of pounds changes hands in
milliseconds. But with EU red tape altering the financial sector's
landscape, technology's evolutionary journey at the London Stock
Exchange is far from over.
Nestling in Paternoster Square in the shadow of St Paul's
Cathedral, the London Stock Exchange, which makes its money through
charging investors fees for trading shares and selling market data,
is a technology pacemaker.
For a trading venue, the faster and more efficiently it can
carry out a deal and the more up to date information it can store
and retrieve, the more attractive it is to investors. These
investors want to buy or sell shares quickly, to prevent changes in
price during the transaction. Accurate market data is also
important for investors to make informed choices.
Share trading took centre stage almost 300 years after share
prices were published twice a week on a 10-by-4-inch sheet of paper
and distributed from
Jonathan's Coffee-house in London. The year 1986 saw what is
known as the financial sector's Big Bang.
It was the end of October 1986 when the Stock Exchange Automated
Quotation system replaced the trading floor. This screen-based
quotation system was used by brokers to buy and sell stock rather
than meeting face to face.
Technology's major impact
The shortening of the period between a trade being initiated and
complete, or the reduction of latency as it is known, is the
ultimate aim of any stock exchange worth its salt.
The Big Bang of 1986 did this and more. "It brought significant
benefits to both institutional and private investors, with private
investors gaining low-cost independent access to the market through
the proliferation of new services," says Robin Paine, chief
technology officer at the London Stock Exchange.
Cheap and efficient trading is what securities traders wanted
and that is what they got. Volumes transacted saw unprecedented
increases, with the average daily number of trades going through
the ceiling.
The trading floor where dealers met remained, and was used in
emergencies while the technology was in its infancy. However, this
soon became a thing of the past as electronically-generated trading
volumes rose unabated.
Just before the Big Bang's meteoric impact, the average number
of daily trades at the London Stock Exchange was 20,000, amounting
to about £700m worth of shares changing hands. After the
introduction of automated trading the figure went up to a daily
average of 59,000 trades a few months later.
In 1987 the London Stock Exchange was transacting as much
business in a month as it did in a whole year before 1986, with an
average daily value of £1bn. Today, the average daily number of
shares traded is 566,000, with an average daily value of
£16.6bn.
These figures would be impossible to reach without technology
that can reduce the time taken to complete a deal and handle
massive volumes.
"Without technology, exchanges could not accommodate the
increased transaction flows that are generated both by the
proliferation of end investors, and by electronic trading,
algorithms and low latency," says Bob McDowall, analyst at
TowerGroup.
The stock market crash
But the technological transformation was not plain sailing. No
major technological advance with such a deep impact on how an
industry operates can be introduced without a hitch.
This was no exception, and the stock market crash of 20 years
ago that saw share prices plummet was more than a hitch, and was
partly a result of the immaturity of the new technologies
introduced in the Big Bang.
Trading in certain stocks could not be stopped and spiralled out
of control. Eventually stocks across the world lost billions of
pounds in value, and the London Stock Exchange lost 23% of its
value in a single day.
McDowall says that although technology and the automation of
selling did not cause the 1987 crash, technology did contribute to
the velocity of the fall in share prices.
"The technology at that time lacked refinement to react to a
wider range of factors beyond the share prices themselves," he
says.
Technology went through a quick facelift after the City woke up
the morning after 1987's Black Monday.
McDowall said the exchange had to introduce circuit breakers
very quickly into the markets. These limited the velocity at which
share prices could fall, before a halt was called to trading in the
particular stock.
Algorithmic trading
These circuit breakers became more important with the
proliferation of algorithmic trading. It is not humanly possible to
manually transact the number of trades done on the stock exchange
today. To reach these levels there must be a certain level of
automation. Hence computers are today initiating many trades using
algorithms.
Algorithmic trading, or "algo trading" as it is known in the
financial sector, relies on computer systems to buy shares
automatically when predefined market conditions are met.
This method of trading is the future, says Paine. "The markets
will continue to be further digitised with the proliferation of
algorithms set to increase. About half of all volume on the
exchange now is electronically generated and we believe this trend
will continue."
The rest is generated by manual intervention where traders
submit orders using an interactive screen.
Jonas Rodny, senior communications manager at the Nordic
Exchange, said although it is difficult to be precise about levels
of algorithmic and automated trading at the exchange, these are
responsible for a significant amount of transactions.
"Our assumption is that both algorithmic and automated trading
are growing very rapidly, currently accounting for at least a fifth
of the overall trading volume on the Nordic Exchange and possibly
quite a lot more," he says.
The Nordic Exchange was created in 2006 by integrating the
exchanges in Stockholm, Copenhagen, Helsinki, Iceland, Tallinn,
Riga and Vilnius. OMX operates the Nordic Exchange and has a
technology arm that develops technology for the exchange as well as
licensing technology out to others.
The London Stock Exchange
Given the technological advancement in the 1980s and the
resulting metamorphosis of the London Stock Exchange, it is no
surprise that the company takes technology so seriously.
In 2003 the exchange instigated its Technology Roadmap, and
after four years the exchange's all-singing, all-dancing core
trading platform
Tradelect was launched.
Since its July launch the platform has set record after record
in terms of the volumes and the values traded. In August this year
the exchange processed a record £17.62bn of transactions in one day
on Tradelect.
But there is no time to sit back and watch in a sector where
technological innovation can so dramatically impact a company's
financial performance.
Constant innovation is essential if the exchange is to be able
to compete with an increased number of trading venues. To this end
the London Stock Exchange's Technology Roadmap II has already been
initiated.
Rodny said the Nordic Stock Exchange's heritage is built on
technological innovation, and the challenges it faces are twofold.
Exchanges need to be able to provide sufficient latency to support
more regular and faster trading, which allows investors to take
market opportunities more quickly.
"The other key challenge arises from the fact that the
continuous increase in volumes puts further constraints on
capacity, not just at exchange level, but along the entire
transaction chain," says Rodny.
The future of European exchanges
Recent forces driving innovation at the exchanges across Europe
stem from the European Union's Markets in Financial Instruments
Directive (Mifid). This piece of pan-European red tape has
introduced more competition in the stock trading sector.
Mifid has compelled EU nations to remove what is known as the
concentration rule that states that all trades must go through
local exchanges. This has been the case for some time in the UK,
but now it is happening across Europe and will inevitably lead to
the creation of more alternative trading and reporting venues.
Two projects known as Boat and Turquoise have been created to
offer trade reporting and execution facilities, respectively, on
the back of Mifid. Turquoise was set up by
Citigroup,
Credit Suisse,
Deutsche Bank,
Goldman Sachs,
Merrill Lynch,
Morgan Stanley and
UBS as an alternative trading venue, while Boat was developed
by a consortium including many of the above-mentioned banks to
offer a trade reporting venue.
KPMG consultant Lee Epstein says
Mifid has opened up the stock trading and reporting sector to
new players because it becomes more attractive for them to be able
to work across Europe. "Before this you had so many different rules
across Europe it was difficult," he says.
A fragmented market
He says the introduction of alternative trade execution and
reporting venues following Mifid will fragment the market, and
technology will be important to differentiate venues.
Nemone Wynn-Evans, head of market development at UK-based
exchange Plus Markets, says innovation will focus on succeeding in
an increasingly fragmented market which increases competition and
introduces new challenges.
"The impact of fragmentation and the lowering of transaction
costs will mean huge volume increases in transaction data, and in
particular market data," says Wynn-Evans .
Technical innovation is required to be able to use all this data
to optimise trades, she says. "The challenge of data volumes is not
just an issue for investors, but also for surveillance functions
and regulators."
Plus Markets, which is a Recognised Investment Exchange in the
UK, is currently installing new trading and market surveillance
technology in conjunction with OMX to expand its stock coverage and
enable algorithmic trading.
McDowall agrees that continuous innovation is essential. "It is
an important factor if it provides business innovation combined
with greater efficiency, speed of execution and reduction in
costs."
Rodny says innovation around speed, capacity and flexibility are
important. "Capacity to take care of the increased volumes, speed
in order to provide algo trading and flexibility to be able to
integrate trading across asset classes and across markets."
So in a computerised environment where high speed, high volume
trading is critical, technology has a strong hand to play.
Add to this the need to retain massive amounts of data and be
able to access it efficiently and you have a boardroom that
appreciates the value of technology and will not shy away from
investing in it.
The London Stock Exchange is an example of how a centuries-old
organisation can meet today's business challenges through an acute
focus on technology innovation.