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Trading Technology

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Andrew Rafalaf
Andrew Rafalaf
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Electronic Connectivity Empowers Buy Side, Threatens Sell Side

According to the results of an Enterprise Technology Consultants (ETC) study, nearly one half of buy side respondents claim they will in the near future trade only with firms that accept order flow and send execution reports electronically.

Electronic trading links to ATS’ and protocols like FIX stand to threaten the very existence of many small to mid-size broker/dealers, while investment managers have more time and room to explore. According to the results of an Enterprise Technology Consultants (ETC) study, entitled "Institutional Equity Trading Technology," nearly one half of the buy side respondents claim that they will at "some point in the near future" trade only with firms that accept order flow and send execution reports electronically. In a telling sign, the buy side is muscling broker/dealers down a road they may not be prepared to traverse.

"The big players all have some level of electronic connectivity, so it’s got to be a smaller player or midsize broker that has zero electronic connectivity," says Joe Rosen, managing director at ETC. "What this is saying is, if you don’t do something soon, you’re apt to lose at least half your business over the next couple of years."

Rosen points out that the study quotes a timeframe of five years, but suggests that a number of industry luminaries predict that this move to electronic trading, all or nothing, will come far sooner. "Jerry Putnam, the chief operating officer of Archipelago, said yesterday (at the Financial Investment Management Conference in Boston) that it’s going to take a lot less time than five years," Rosen points out. "His prediction was that this would happen in two years. I’m not sure about that, but it definitely highlights the pressure."

The ETC study, which received responses from the CEOs and heads of technology from 91 buy- and sell-side firms, points out that a larger percentage of broker/dealers have come to utilize order management systems, ECNs/ATS’ and the FIX protocol. While only 31% of institutions use FIX now, nearly 82% of brokers do, and of those sell-side firms that have yet to employ FIX, 100% of them plan to within a year. Rosen explains that money managers have more time to adopt such devices while the broker/dealers must pander to the needs of their buy-side clients.

"Brokers are the ones providing execution services to the buy side, so the use of FIX and trade order management systems is far more prevalent on the sell side because they are providing the service," Rosen explains. "They don’t want to risk losing buy-side orderflow. With the buy side, it’s a much smaller percentage of the industry. The large firms like Fidelity and Putnam are driving this, but the smaller firms can act more slowly. Quite simply, a broker will still take their orders."

These numbers do not predict easy sailing for the money managers, though. A total of 51% of the buy-side respondents and 67% of the sell side expect electronic exchanges to supplant floor-based exchanges in the next 5 to 10 years.

"Electronic connectivity is getting to the point where it’s no longer a competitive advantage," he adds. "We are very close to the point where, if you don’t have it, it will knock you out of business."

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