Equities: A Fintech First Mover
Electronic trading. Algorithms. Smart order routing. Co-location. Workflow automation.
Most every technological advance in the evolution of institutional securities trading happened in equities first. And the ubiquitous business of buying and selling corporate shares — which covers about $69 billion in global market capitalization, $28 trillion in the U.S. — continues to be a fintech standard-bearer.
Financial technology has compressed execution speeds to microseconds and massively upgraded trading-desk efficiencies, ultimately reducing commissions for end-user investors. It has also increased the risks associated with trading glitches, as damage can ripple through today’s high-speed electronic markets much faster than when bourses operated via manual processes.
“Technology has improved markets in terms of efficiency and transparency, but this has not come without inherent challenges,” said Kirsten Fraunces, co-head of equities at Wedbush Securities. “The current market structure is more complex than in the past.”
The story of technology in the stock market is a long one, harkening back to black-and-white photographs of ticker-tape machines on the floor of the exchange.
Bill Harts, chief executive officer of Modern Markets Initiative and a 27-year market veteran, noted that in the 1960s, the New York Stock Exchange would close on Wednesdays to process mountains of paperwork, and at one point more than 100 brokerage firms failed because they couldn’t keep up with the effort demanded by manual processes.
“The early adoption of technology was a matter of survival,” Harts told Markets Media. “But once The Street began employing computers, uses beyond processing trade paperwork became apparent.”
Pioneers in electronically sending orders to the point of execution included the Pacific Coast Stock Exchange as well as the NYSE. The next step was electronic execution.
“It is a little-known fact that the first exchange to allow fully automated execution was the Cincinnati Stock Exchange,” Harts said. “A few forward-looking people there decided to create a system that could operate without humans entirely. Known as NSTS, its role in moving the industry to electronic execution has been largely forgotten, but it was an important first step.”
Fast forward to 2016 — electronic trading is firmly entrenched, and initiatives are focused on raising the bar on a multitude of fronts to make the process faster, more reliable, and more efficient. As trading and investing firms have their own unique style, so do they have different fintech needs.
“Some folks are keeping costs down by leveraging the cloud and more agile ways of developing software and managing hardware,” said Richard Herr, managing director in the investment banking group of Sandler O’Neill. “Then the folks who are very latency-sensitive, who need to keep their execution speeds as low as possible, are spending significant resources to make sure they’re co-locating in the right place and that they have the best short-wave telecommunications technology.”
As the interface between end-user investors and market centers, brokers arguably have the most at stake when it comes to technology. A suite of top-shelf coders, infrastructure and systems is a differentiator; a subpar offering is a prescription for failure.
“From the perspective of a sell-side desk, challenges that we face include but not limited to market fragmentation, sourcing liquidity, price discovery, and being gamed by other market participants,” said Sahak Manuelian, managing director at Wedbush. “Technology has improved stock spreads, institutional and retail trading costs, and price efficiency. On the other side of this argument, many professionals and industry experts claim the market is not a level playing field as some investors have an unfair technological advantage.”
Finding the other side of a buy or sell order, with the least friction possible, is the primary objective for brokers. Technology is critical in this quest, especially for mid- and small- capitalization stocks that aren’t traded as often as Apple, Google. Facebook and other mega-caps.
“We rely on access to the best technology in order to aid us in sourcing liquidity with minimal market impact and delivering best execution to our clients,” Manuelian said. “As technology has improved over the years, we are able to make changes to algos with ease and our providers do a better job of assisting us with offering suggestions based on historical data of our workflow.”
With assistance from John D’Antona
Previously in this series:
Featured image by Myimagine/Adobe Stock
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Trading exec’s mandate: add more dealer quotes.
Inaugural FIMSAC meeting highlights how market participants are adjusting.
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Will central clearing of Treasuries be in the cards?