Open Season on Exchanges

if it’s so easy to build an exchange from scratch, why are officials at the largest and most successful futures exchanges in the world racking their brains over going electronic?

As if it were so simple, today, everyone and his brother wants to create an exchange. Bandwidth, electricity, credit derivatives, weather derivatives and foreign exchange are just a few examples of the feverish trend.

Name any niche commodity and chances are someone, who is enamored with eBay, is building a Web site to link buyers and sellers. Just look at the proliferation of ECNs and online bond trading systems as proof that anyone with a business plan and venture capital funding can create one.

But if it’s so easy to build an exchange from scratch, why are officials at the largest and most successful futures exchanges in the world racking their brains over going electronic? Fear of cannibalizing the liquidity and profits associated with their open outcry floors is a key reason. See “EBOT, The Missing Link,” p. 18. And what’s worse, they’re facing competition from pipsqueak rivals that are expected to co-list their flagship products.

As exchanges migrate to electronic platforms, the management of technology becomes more critical, as all firms are discovering. See “Juggling Technology Relationships,” p. 27. Not only are exchanges becoming more dependent on technology, but they are beginning to use common trading platforms. In contrast to the 80s and 90s when they developed proprietary protocols and interfaces to which member firms had to hire an army of programmers to connect, exchanges are adopting standards and friendlier interfaces to promote connectivity.

Indeed, the platform will become more co-dependent. As the CBOT’s alliance with Eurex and the CME with Liffe illustrates, the days of building a killer app in Internet time are dead. Instead, the new breed of financial markets will initiate technology-sharing deals. This is especially true of fringe exchanges. Upstarts such as The International Securities Exchange, approved in late February to trade equity options, and BrokerTec, an online bond trading consortium, have both selected OM Technologies. Other vendors reaping business from the trend include GL Consultants, a subsidiary of the Paris Bourse, Trading Technologies, as well as the Deutsche Borse powering Eurex.

While electronic exchanges will be more nimble to compete technologically, linkages and Internet access will also make them more vulnerable to a host of technology risks, ranging from technical glitches to disasters, viruses, cyber-terrorists and even teenage hackers. The recent hacker attacks on eBay, Yahoo, E*Trade and other sites, including National Discount Brokers and the FBI, underscore the risks of doing business on the Internet. See, “Hacker Attacks Wake Up Financial Firms to Security,” p. 10.

So while the trend toward electronic exchanges that are global and trade 24 by 7 holds great promise, there’s no mistake about it—virtual borders are more accessible to intruders. When hackers can implant a program in thousands of remote computers, and issue a command that drowns a target in torrents of meaningless data, exchanges may want to batten down the hatches, and stick to VPNs. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio