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FLASHBACK FRIDAY: The Mixed Blessing of Technology Spending - Desks Must Spend on Technology to Remain Competitive
Traders Magazine Online News, June 2, 2017
The more things change, the more they stay the same.
Technology has been said to be the one constant in an ever-changing world. Back in 1998, trading floors such as Nasdaq’s, were coping with new technologies – like the Internet, FIX Protocol and others - that while costly, was needed for survival in the 21st century.
Instinet's John Comerford painted a picture of the market back then.
"In 1998, Instinet's core technology was being transitioned from a PDP11 to Unix. Market-wide connectivity was different," Comerford said. "For NYSE names, there was DOT, where response times were in the seconds. For NASDAQ names, Instinet's ECN was the place to trade. And everyone was dedicating resources to Y2K."
Fast forward 17 years and technology remains a top requirement to effectively conduct business. Whether one is on the buy- or sell-side, having the most up-to-date technology is a perquisite to getting business done. But there remains the constant conundrum of how much to spend versus how much the amount spent contributes to the firm’s bottom line.
Robert Dykes, CEO of OEMS provider TORA said that in the late 1990s, the move to decimalization and regulations like Reg ATS and Reg NMS contributed to technology costs accounting for the largest budgetary line item outside of headcount for the industry.
“That trendline has continued unabated for nearly 20 years since, though we seem to be reaching a tipping point with how much technology cost the buy side and sell side are able to bear,” Dykes said, “ Many technology firms are starting to recognize that reality and those that can deploy solutions that align with these budgets are well positioned to replace legacy technology providers with large fixed cost infrastructure.”
One broker executive told Traders Magazine that his firm’s technology spend was upwards of $30 million for the latest calendar year or between 5% and 6% of its total expenses. This includes enhancements of existing software, the ongoing development of new software and services and investment in technology to enhance efficiency. And in a static commission rate envrionment, that's a significant portion, the executive added.
Other firms said they were spending more.
So where does the line get drawn between technology spend and technology benefits? It looks like there’s no certain answer in sight now, as it was back in 1998.
This article originally appeared in the June 1998 issue of Traders Magazine.
Huge mainframes. Fiber-optic networks. State-of-the-art telecommunication systems. Worldwide market news delivered real-time.
Sound familiar? It should. These and more are at the very heart of a Nasdaq trading room.
Back in the pioneer days, much of what is today's Nasdaq trading-room technology did not exist. By contrast, some of today's technology has a pedestrian aura.
The consequences of that might be viewed as a mixed blessing desks have no choice but to collectively spend billions of dollars to remain competitive, but in return they transact business at an exponential rate.
Now Nasdaq, an electronic marketplace, is grappling with technology changes as never before.
Electronic communications networks (ECNs), such as Reuters Holding's Instinet, New York-based Investment Technology Group's POSIT equity matching system and an upstart crossing network, MatchPoint, developed by The AutEx Group and State Street in Boston, are helping to raise the stakes.
Never known for avoiding a challenge, the Street is embracing all this technology and more.
Three Areas
According to the latest institutional-equity study by Connecticut research firm Greenwich Associates, spending on technology is going to explode in the coming year.
Much will primarily be spent in three areas of Nasdaq trading: simplifying trading desks, deploying the Internet and client services.
"More and more firms are looking to deploy technology because the market has become extremely competitive, and recent regulations have cut into the spreads," said Lawrence Tabb, group director at The Tower Group, a Newton, Mass.-based consulting firm, referring to the order handling rules.
Tabb says that firms will use technology to make their operations more efficient and profitable.
To begin with, Tabb feels that desktop enhancements will be a priority for market makers, "because traders have to keep a grip on the various places they are trading in."
"When we started, there was the Nasdaq trading terminal and the Quotron," said Tom Norby, head Nasdaq trader at Portland, Ore.-based Black & Company. "Now there are so many platforms that you need to be a wizard to stay on top of every single one."
For one thing, the number of ECNs is on the rise. Besides Instinet, other ECNs include Bloomberg TradeBook. (Greenwich noted that 57 percent of all traders now report using Bloomberg terminals.)
Coming down the pike is BRUT, or the Brass Utility, developed by Automated Securities Clearance Corp., a Weehawken, N.J.-based company, and STRIKE, a Bear, Stearns & Co.-backed ECN.
Usage
According to Greenwich, among institutions generating more than $5 million a year in commissions, 82 percent now make use of non-traditional systems for Nasdaq business, up from 75 percent in 1995 and 1996.
The study notes that these same firms are expected to do 22 percent of their business in 1998 on non-traditional systems, up from 20 percent in 1997.
"Ten years ago, if you were an institution, you had to go to a Nasdaq trader to buy a stock," Tabb said. "Times have changed. Traders have to keep clients happy."
It is no surprise that technology budgets are being earmarked for running Nasdaq and ECN software as well as data feeds on one screen, instead of several standalone terminals.
"Traders won't have to deal with so many boxes anymore," Tabb said. Norby's Black & Co. is planning to run ECNs on one computer, allowing traders to view data in several windows on a single screen. Clearly, the plan would help cut operating costs.
As always, costs are uppermost on traders' minds. According to Greenwich, institutions paid an average 6.4 cents per share on listed agency trades, 6.6 cents per share on Nasdaq trades, and only 3.8 cents a share on ECN-based transactions for the year ended January 1998.
While the numbers appear to give ECNs a competitive edge, there are factors worth noting that make listed and Nasdaq commissions higher than ECN commissions.
For one thing, institutions use some brokers on listed agency business chiefly for soft-dollar services.
Nevertheless, the lower commission costs on ECNs have clearly helped them to gain market share.
Internet
The Internet is another hotbed of technology spending. And it is helping desks achieve another goal improving client services.
Buysiders see the Internet as an important source of after-hours research, according to the Greenwich study.
The same study finds an increasing number of institutions want their broker dealers to supply them research via the Internet.
What's more, broker dealers are bowing to the demands of their clients even as spreads shrink.
WorldStreet Inc. of Cambridge, Mass. provides sell-side trading desks a product that helps them share information more easily with buy-side clients, giving them around-the-clock service, seven-days-a-week sell-side access via the Internet.
The Internet is expected to be deployed for the National Association of Securities Dealers' Order Audit Trail System, or OATS.
OATS is a real-time electronic system, which gathers and reports up to 25 trade details from order-entry to order execution. OATS will replace current trade reporting that requires certain data to be sent to the NASD within 90 seconds of execution.
OATS will be implemented in phases. As part of the first phase, by March 1, 1999 electronic orders received by ECNs or at the trading departments of market makers will be subject to OATS reporting.(Electronic orders are defined as orders that are captured in an electronic order-routing or execution systems.)
FIX
Meanwhile, speed is becoming a buzz word.
"Brokerages are using FIX more extensively to become more responsive to their clients' need for faster delivery of research and other data," Tabb said.
FIX, or the Financial Information Exchange, is a communications protocol that enables securities firms and institutional investors to interact electronically.
This set of data structures and rules is radically changing the way financial counterparts communicate, enabling efficient distribution of information and transactions among a larger selection of trading partners.
FIX protocol was rolled out in 1992 after mutual-fund giant Fidelity Investments requested its broker-dealer trading partners to more fully automate the interaction among broker dealers and buy-side trading desks.
In 1993, several firms banded together to create FIX's comprehensive open standard, allowing firms to communicate indications, orders, confirmations and trade-allocation information, virtually without charge.
FIX is currently being adopted by the majority of U.S.-based equity buy-side and sell-side trading-platform vendors, and is gaining global acceptance as well.
The protocol is also being embraced by U.S. equity exchanges, trade-matching facilities and order-routing systems, and is quickly becoming the default standard for communicating all equity-trading information in the U.S.
According to Greenwich, the FIX protocol is now used by 21 percent of investors generating more than $20 million in commissions, up from 12 percent. On the growth side, Greenwich noted that 40 percent of the largest funds plan to use FIX protocol, and 35 percent all of investors generating more than $5 million are likely to be users.
The FIX protocol, combined with the Internet backbone, has enabled firms to create a global financial infrastructure, linking firms and branches seamlessly, Tabb says.
As more firms gain confidence in electronic trading technologies, and more platforms provide FIX-enabled order routing, Tabb believes that the number of trades and allocations routed will increase to approximately ten percent of total FIX traffic by the new millennium.
Priorities
When Greenwich asked institutions what changes they would most like Wall Street to make, many of their answers referred to technology-based services, said Greenwich consultant Phil Kemp in a foreword to his firm's report.
A striking number of institutions say they would like brokers to convert to electronic trading, said another Greenwich consultant, Bjorn Forfang, noting that many institutions are looking for new types of research services.
A sampling of other comments noted that some institutions wanted better electronic delivery of research and the ability to download spreadsheets.
"Targeted delivery of research [with] more active use of the Internet [is needed]," said one institution. "More efficient formats for electronic transfer of data," added another.
But all these technological enhancements do not mean anything to sell-side traders such as Norby.
"Ultimately, I need a reliable system which brings some value-added to my business and does not break down on me," he quipped.
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