Leader : Its all about trading
Neil ChrissPresident, ICor BrokerageA Reuters Venture
Adoption of electronic trading is a certainty for almost all
markets says Neil Chriss, despite proponents facing a contingent of
doubters in each market, including foreign exchange.
Adoption of electronic trading is a certainty for almost all
markets virtually every liquid market in the world where electronic
trading has gained a foothold is now dominated by electronic
trading. The only questions have been who will dominate, how long
it will take and the completeness of the transition. Of note is
that in almost all cases the incumbent, non electronic offerings
have lost volume hand-over-fist to the newer electronic offerings.
This phenomena has occurred in quite a broad range of financial
markets, including futures (consider that Eurex, the worlds largest
fully electronic derivatives exchange, was founded in December of
1996 and is now leagues ahead of its non-electronic competitors,
leading Liffe, its chief European rival, by three times the
volume), spot foreign exchange in the interdealer market (consider
that Reuters and EBS are fully electronic and have almost
completely displaced old-time voice brokers, leaving them less than
twenty percent of the volume), and equities (consider ECNs with the
exception of Instinet were founded when Nasdaq was forced to change
its order handling rules in the late 1990s, now handle roughly 40%
of Nasdaq share volume).
There are many other examples, including US government bonds and
foreign exchange forwards, which are rapidly gaining ground against
their voice competitors. The bottom line is that if there is a
liquid and standard instrument to be traded, the market has always
chosen electronic trading as its primary means to get this done.
Now for some sobering news. The rate of adoption in electronic
markets when there is an existing non electronic, people based
provider is precarious indeed. While adoption is close to certain,
the exact timing is anything but. Still worse, the pattern of
volume growth is distinct from traditional businesses where slow
steady growth makes extrapolation and forecasting relatively
straightforward. Adoption trends in almost every financial market
have followed more of a sideways S shaped model, with a long period
of low usage, followed by a sudden surge in activity. This pattern
is best explained by the necessity of a critical mass of
participants and activity before serious trading volume can emerge.
It is also predicted by the basic theory of network economics,
which states that the value of a market in which all participants
can interact with all others, grows in importance proportional to
the square of the number of participants.
Be that as it may, market participants do not care about the
mathematics or the historical precedent. They are rightly focused
on their markets and their particular problems. Thus despite the
strong historical precedent for markets becoming electronic, each
new market with electronic offerings faces a contingent of doubters
decrying the impossibility of this market going electronic, because
this market is different and has certain peculiarities that will
prevent electronic trading from taking hold. And so it is the case
with many of the foreign exchange offerings today such as
electronic markets for foreign exchange derivatives.
In the case of derivative markets, the chief set of doubts focuses
on the strength of the relationship between brokers and traders:
the traders need the brokers to provide the liquidity, doubters
say. It might surprise some to know that this is quite a common
objection to all sorts of situations where a machine is proposed as
a replacement for a job traditionally for a person. In fact, the
ubiquitous automatic teller machine, variously called an ATM,
cash-point and cash station around the world, faced exactly the
same skepticism just over thirty years ago. At the time, Don
Wetzel, who co-invented the automatic teller machine, was trying to
get banks interested in using his new system and remembers the
The mentality of people at that time was, remember, we want to deal
face-to-face with people. People are not going to walk up to a
machine and use it. In fact we don't want them to do that, we want
them coming to the bank and talking to us, because then we can sell
them on some other things.
The problem was that nobody really saw the need for an automatic
teller machinein principle they might be more convenient, but
tellers know their customers in a way that a machine will never be
able to, and can help with an array of complicated transactions
that a machine would have difficulty handling. Plus, tellers are
fast, convenient and nobody sees the need for improvement, even if
there is room for it.
Today, of course, that ATMs are the preferred choice for customers
for all but the most complicated transactions is an understatement.
Most banking customers would rather wait five minutes on an ATM
line in an ice storm than use a teller. Yet thirty years ago bank
executives viewed the ATM with tremendous skepticism. They argued
variously, People will never trust the machine, customers prefer
tellers, tellers point out mistakes and protect their customers,
tellers can suggest other transactions from which people might
benefit. All important points, but not one of them means a thing to
customers or bankers today. And the reason? It has to do with the
fundamental way customersall customersview business transactions.
People think of business transactions not in terms of the nature of
the interaction necessary to complete the transaction, but in terms
of the results they hope to achieve. People rarely say, I am
looking forward to having a nice chat with my broker and Ill also
get some business done too. A trader thinks about a transaction in
terms of a certain product, a certain amount and a certain price.
The rest is just a means to an end, and what the trader wants is to
get to that end as quickly and efficiently as possible. Therefore,
again and again, individuals across all different kinds of markets
and a vast array of businesses gravitate toward the easiest,
quickest and most efficient way to transact.
And, even more importantly, it turns out there is no such thing as
fast enough, easy enough, or cheap enough when it comes to business
dealings. If a faster, easier and less expensive way emerges,
customers jump. This was the experience with ATMs as Mr. Wetzel
The bankers always said, "Our customers, they know Susie [a
hypothetical bank teller], they've known her for a long time, and
they feel very comfortable coming in and talking to her. And Susie
likes to talk to them." Neither was true. Susie didn't know the
customer. I didn't know my teller. I didn't go to the same teller,
especially if this line over here was shorter. I went over there
and I couldn't have cared less who the teller was.
What they found was the relationships did not run as deep as people
thought. All the customer wants is the fastest, easiest and
cheapest way to transact. And there is no way, it is impossible,
that voice brokeringor even something brokers are calling hybrid
tradingcan compete with the speed and efficiency of electronic
trading (imagine calling your broker after making a stock trade
on-line to check to see if everything went through ok).
Despite electronic tradings bright future, the transition to a
fully electronic market does take time. Some traders are reluctant
to walk away from tried and true relationships with their favourite
brokers. Others are quick to point out potential difficulties in
using electronic broking as opposed to brokersbrokers can protect
my prices in fast moving markets, systems cannot, brokers can point
out mistakes, systems cannot. But every new technology, no matter
what advantages it offers, requires an adjustment from its
adopters, and there are always some who can only see the pitfalls.
Interestingly, every market from ATM machines to futures markets,
that has made the transition from a people based to an electronic
based system has offered the exact same set of reasons why it is
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