The Handbook of Electronic Trading - an Intro

by Joe Rosen, President, RKA Inc.

Wow! Now it’s really here, the book I have always wanted to do. After all these years, and countless questions asked of many industry wise men/women at countless conferences and seminars– and not least, the year since we started this exciting project – at last The Handbook of Electronic Trading has been published. Fifty notable industry friends and clients from 36 organizations were so giving of both their time and expertise, and so patient – we expected some 12-15 chapters, and ended up with 43, which took much longer than we had anticipated.

The diversity of views and opinions that the reader will benefit from is clearly matched by the broad, cross-section of backgrounds, experience, responsibilities and subject matter expertise of the chapter contributors. In terms of organization type, geography, industry sector and asset class, as well as title, our participants cover the spectrum from equities and fixed income to derivatives, to buy-side as well as sell-side algo trading heads, to academic researchers, journalists and chief economists, to senior executives, such as CEO and CIO, at exchanges/ATSs/ECNs [defined below], consultants and vendors. Our approach, likewise, is a global one. A range of functional areas is also represented, including trading, operations, IT and compliance/regulation. It is fitting that we have such a stellar cast of contributors, as the subject of ‘electronic trading’ is such a broad one. We were as duly diligent in our selection of specific topics – and cognizant of the need to cover as broad a swathe as possible – as in inviting participants.

This is a most exciting time in the industry, with so much changing all at once. Some are calling this a perfect storm, buffeting the global securities industry with an unprecedented combination of forces. Hardly a week goes by without one or more articles about consolidation, convergence, dark pools and many other buzz words appearing in the Financial Times, Wall Street Journal or Economist. Much, if not most of this metamorphosis is related to the nearly exponential growth of ‘electronic trading’, which appears close to finally taking over the entire industry globally. One would be hard pressed to dispute that it’s long touted benefits are more and more apparent, for example, reduction in errors, speedier order processing and customer service, more efficient and less pressured traders, and most importantly, cost savings that go straight to the bottom line.

When I started my Wall Street career some 25 years ago, and was fortunate enough to have actually written code for one of the first automatic execution systems for equities, the industry was a radically different place that would be unrecognizable today. In those days, it was all but a blank slate for trading automation, and ‘electronic trading’ meant many things, depending on who you asked. The first critical step was getting rid of the paper – the hand-written, order tickets, and the manual trade blotter. It is hard to imagine that at the time Wall Street – and the City -was still recovering from the ‘back-office crunch’ of the late ‘60s. As the trade magazine Wall Street Computer Review put it at the time, “Until nearly 1970, the securities business was wholly paper-based and manually processed. Ten or eleven million shares a day on the NYSE was a real back-breaker.” [“Computer Speed May Eliminate Bargains in the Stock Market”, Wall Street Computer Review, January 1984, p.38. This publication is now called Wall Street & Technology.]

Fast forward to the mid ‘00s. The first time I ever heard anyone talk about measuring price dissemination and order execution times in milliseconds was when I was serving as chairman of an industry conference on, what else, ‘electronic trading’. And I naively thought that either they were joking, or I had misheard? Boy was I wrong; and they certainly weren’t kidding! Now for better or worse, we already hear of some ‘execution mechanisms’, aka ECNs, ATSs, SIs, MLTFs, etc., claiming ‘latencies’, i.e. turn-around times, in microseconds, yes, millionths of a second. [For those who cannot wait for the above acronyms to be defined and described in chapters to follow, they stand for, respectively, ‘Electronic Communications Network’, ‘Alternative Trading System’, ‘Systematic Internalizer’, and ‘Multi-Lateral Trading Facility’.]

At the same time that we have seen so much change, in some sense the more things change the more they stay the same, and nowhere more so than in the blurring of distinctions between players, and particularly, the growing competition for the trade execution business between exchanges and the multitudinous types of broker/dealer owned and operated trading systems, some of which are mentioned in the preceding paragraph. This phenomenon was quite elegantly and humorously captured some ten years ago by Ruben Lee, in the introduction to his book What Is An Exchange? The Automation, Management, and Regulation of Financial Markets (Oxford University Press, 1998), “… New technology, however, has led to the birth of a previously unknown type of institution, the ‘MONSTER’ (a Market-Oriented New System for Terrifying Exchanges and Regulators) ….. .” [page1]. Interestingly, if we go back another 15 years, it was already an issue on the regulators’ radar screen. In a 1984 article dealing with ‘automated systems’ for trading, the Wall Street Journal writes “The commission [SEC] agreed with a staff recommendation not to force a decision on whether new systems allowing brokers to trade over-the-counter stocks electronically are really new stock exchanges. …. Technically, the staff said, the system operators could be deemed exchanges and be subject to the extensive regulation now applied to the New York and American stock exchanges.” [“SEC to Encourage Automated Systems For OTC Trading”, Wall Street Journal, October 5, 1984, p.53]. This is clearly one hot potato that has not gone away, and that the regulators must still figure out how to deal with.

Given the increasing pervasiveness of electronic trading, both globally and across asset classes, we expect that The Handbook of Electronic Trading will be useful to executives throughout the industry. The primary objective is to provide practical discussions – and actionable ideas - that will help seasoned executives as well as newcomers to the industry deal with both current and future challenges related to the growth of electronic trading.

For those readers who are not – yet – sufficiently mindful of how competitive forces can and do totally reshape industries and the ‘pecking order’ of players, let me share another cautionary tale back from the beginning of the PC revolution in the early 80’s, and one that Joseph Schumpeter would have greatly appreciated. In those days, the market data business was basically controlled by the ‘QRT’ three [Quotron, Reuters and Telerate]. Two are gone, while the third has merged with another player that did not compete in the business segment then. Why one of the two disappeared becomes quite obvious when you read how one of their senior executives was quoted in a trade publication article at the time; you can’t make this stuff up: “If I honestly believed that the solution was to place a personal computer on the desk of every account executive, I swear to God I would recommend it to this company. I do not believe it. I do not think it is practical. I do not think it is controllable. I do not think it’s the way Wall Street should go!”, [“Wall Street Back Offices Win Control of PCs”, Wall Street Computer Review, September/October 1983, p.51]. The clear ‘take-home’ lesson here is do not be complacent, and certainly do not underestimate the potential impact that new technologies can have on the competitive landscape.

The 43 chapters – including the preface that follows this introduction – that comprise The Handbook of Electronic Trading are organized into three sections, which will be familiar to readers of my two prior ‘Handbooks’ – The Handbook of Investment Technology[McGraw-Hill: 1997], and The Handbook of Fixed Income Technology [Summit Group Press: 1999]. The nine chapters in Section I, Evolution of Electronic Trading, together present a management level perspective on where the industry is, how we got here, and where we might be headed. Section II, Electronic Trading Applications & Practices, contains 23 chapters - a wide variety of case studies of business-segment-specific uses of electronic trading, everything from ‘Algo Trading’ and ‘Dark Pools’ to ‘DMA’ and ‘EMSs’, to ‘MiFID’, ‘Reg NMS’ and ‘Smart Order Routing’ among other topics. The ten chapters in Section III, Technology & Electronic Trading, discuss specific technologies – and related issues - that continue to facilitate the electronic trading revolution. Included are topics such as FIX, complex event processing [CEP], trading floor architecture, and ‘Build vs. Buy’. A couple of the chapters in this section are geared towards the more technically astute among us. You will know which chapters – and your level of technical astuteness - when you (try to) read them.