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The relatively cosy world of data provision is under attack like never before. The world has changed from the environment where the first blinking black and green Reuters screen was introduced back in the early 1970's. For a start, 30 years ago the only competitor for getting live prices off the trading floor of stock exchanges was the telephone. Technology has moved a great deal since then. Secondly, marketplaces are no longer confined to regulated exchanges; the number of potential sources of the same data is increasing rapidly.
Traditional exchanges face some very serious threats to their dominance of market data provision. The flip side is that there is ample scope for significant improvement in the way in which exchanges benefit from the data they generate. The next few years are going to see a transformation in the way in which both retail and professional users obtain data. Two things are certain: change WILL happen, and some organisations will lose as new winners emerge.
Any electronic trading system that has sufficient depth of market and therefore sufficient liquidity is now able to publish its prices. It is a truism that the quality of price is dependent upon two things: liquidity; and the depth of market of the system that publishes the price. The emergence of a new generation of trading system threatens to strike at the very heart of the business of the traditional exchanges. Furthermore, the fact that the cost of distributing the data and the cost of bandwidth, have come down in price so much since the first Reuters screen blinked into action, has left the financial service industry in a state of incredible change. A new infrastructure is quietly being born.
The first threat to traditional exchanges came in the US in the Nineties when electronic communications networks began to take order flow from the exchanges because they could electronically show a bid and offer tradable price. Price discovery, of stocks listed not on the ECNs but on traditional exchanges, attracted order flow. Nasdaq has taken this shift in perspective very seriously and is building the ECN to end all ECNs in the form of SuperMontage, which, it has argued with the regulators, will create a level playing field by displaying the prices across the various ECNs for a Nasdaq stock. The fight for the display of best price continues.
In Europe, a 60/40% joint venture between OM Group and Morgan Stanley, Jiway, has given traditional stock exchanges reason to pause for thought. The model, a cross-border stock exchange network, saw the market-making banks and brokers undertake to quote prices in a specified number of stocks on Jiway. Jiway guarantees that this price will be as least as good as that on the stock's underlying exchange. The launch of Jiway in October 2000 now means that the last traded price of some 6,000 US and European stocks are pumped out across a network of brokers, real time, and more to the point, free.
This, Lynton Jones, Chief Executive of Jiway, (formerly with London Stock Exchange, Nasdaq and OM in London) believes is the central lesson to be learnt from the past. In no other industry do the buyers have to pay to find out the price of the item they are buying. The traditional exchange is currently in a win-win situation - the seller (or listed company) pays the exchange to publish information that it is regulated to provide, and the buyer of the company's stock pays the exchange a membership fee for price discovery.
The key motivation behind the establishment of Jiway was to overcome the traditional model — where exchanges were, in actual fact, creating a barrier at the point of trading — placing obstacles between the trading party and their acquisition of a price. The members of the exchange, many of which are shareholders, may not have objected to paying for price data, but the investor is less inclined to find this acceptable, especially in an age of Internet free information and the push for greater transparency and unbundling of services.
Jiway removes and openly flaunts this traditional model simply by focusing on the price of the stock, rather than the price data. It is no secret that a large chunk of revenue of traditional exchanges comes from the dissemination of pricing data. After transaction fees, for most exchanges, price data, sold either directly to its members or collected via quote vendors, is the second largest source of revenue. In the year ending April 2000, the London Stock Exchange, which levies a charge direct to its members for market data dissemination, collected almost GBP73m.
It begs the question of who owns the data? Is it actually the exchange property to sell? Jiway works on the premise that the prices are being created by the buyers and sellers and therefore belong to them, so prices are provided free of charge to them.
Traditionally, the exchanges are the financial markets' pools of liquidity. The only way to create sufficient liquidity is, to have liquidity in the first place. Just as in the world of science, the more mercury you have in a blob, the more mercury the blob will attract, until the larger mercury pool has attracted and absorbed all the smaller blobs in its vicinity, market liquidity attracts further liquidity. The more trading there is in a single marketplace, the more liquidity there is. The more liquidity there is, the easier it becomes to trade, therefore attracting more order flow and building more liquidity. It's a very powerful virtuous circle when it works. There are few instances where the exact same instrument is traded successfully in multiple locations. It was only for a short time that liquidity in the Bund future, traded on both the London International Financial Futures Exchange and Eurex (formerly Deutsche Terminborse), was equally split. For many years, Liffe held a 70% market share. For a relatively short time, months rather than years, the two exchanges battled it out as the electronically traded German contract gained a higher percentage of market share. Today, the contract barely trades on Liffe.
These days it is no longer really about exchanges rivalling each other. They are all in very much the same position. It is more about how exchanges are dealing with the threat from the growing number of electronic marketplace and portals — the ECN and the Automated Trading System model. In the end, when one strips away the tradition, an exchange is just a space where buyers and sellers can trade efficiently, and there are many organisations that can replicate the liquidity they represent.
The lack of an exchange traded price for many of the new electronic marketplaces means that the price is coming directly from seller and buyers only. The fact this price can be seen by a potential buyer free of charge immediately reduces the value of price data for all ECNs and exchanges. There is still a need to attract and improve liquidity, and that can only come from higher volumes and lower transaction costs.
But now there is evidence that the tables are turning. One example is when the London International Financial Futures Exchange (LIFFE) launched Universal Stock Futures. Live, real time prices are available via Liffe's website, and in turn, although the quote vendors carry the prices, Liffe is not charging quote vendors for carrying these prices. Why did LIFFE do this? Two reasons: because the exchange was seeking to court the retail investor, who of course has no experience of paying for price discovery anymore than they would pay an entrance fee to their local supermarket; and also because Liffe is intent on building leading market share. For stock futures, market share is more important to Liffe than data distribution revenue. Looks like LIFFE is playing by a new set of rules.
If you are running an exchange, these changes could be viewed as bad news - after all, we are talking about your second largest revenue stream becoming free in order to protect your largest revenue stream.
There are potential solutions that will preserve the revenue value of the data.
Deutsche Börse, has employed the services of a company called Cicada, established by former Dow Jones Markets (Telerate) Executive Greg Smith to enable the owners of market data to empower themselves, to build what is aptly named a Consolidated Exchange Feed (CEF). The Börse's CEF collates all the data generated by the exchanges using the Xetra trading platform, verifies, cleans and sorts it and then sends it down a single pipe to the quote vendors. Christoph Lammersdorf, executive member of the Deutsche Börse board, and also a former director of Dow Jones Markets, says that the Exchange is not cutting the data vendor out, but simply making life easier for them by delivering the data more cleanly, rather than from several different sources. But, in so doing, the Exchange is more aware of what data it supplies and how it is presented. Since doing this, he adds, the same data can now also be delivered through Xetra screens — for those who do not have a quote vendor, or choose to have the data on the Xetra screen. This does can mean the member saves on the cost of a Reuters' screen, and that it pays the exchange direct for the market data
Liquidity providers in other asset classes are moving in the same direction as Deutsche Börse. If you represent the greatest pool of liquidity for an asset then your price is the price and you can charge accordingly. If you have a lower quality of liquidity then perhaps making the prices free can assist in improving the liquidity and therefore the value of your prices.
So just as Liffe decides it would rather have volume rather than market data revenue, Deutsche Börse is going the opposite direction in realising the value of its data. Both exchanges are right in realising they need to take control. New markets are making pricing data free either because they accept that it belongs to the buyers and sellers who make the price, or to build liquidity. But exchanges already have the liquidity. While they may be forced to consider giving data free simply because so many other bank-led initiatives will force them to, they can improve the commercial quality by taking control of the data and becoming less reliant upon the quote vendors.
The banks too have taken control of the data, or prices, they generate. This has been seen most obviously in foreign exchange, but increasingly in the OTC derivatives and money markets, where banks have built Internet spot forex services themselves or used ASP solution models such as Cognotec or AVT. Logicscope has worked closely with Cognotec to deliver price data direct from the banks' dealing rooms in real time to an automated web-based server.
Speaking on behalf of the Information Providers Users Group (IPUG) at the annual Dealing with Technology conference in London in April, WestLB's John Best told delegates of a fast changing world in which the users of market data were becoming empowered. The upshot of this, Best said, was that the quote vendors would eventually be disintermediated, as users of market data use technology to build their own hubs using direct feeds. "The only thing that is standing in the way," Best warned, "was the need for standards to emerge." The next generation language that every IT vendor, exchange and bank is working on, XML, is already a proliferation of schema.
A persistent theme through this article has been the need for producers to take control of the data they produce. Taking control might mean going around the data intermediaries and establishing direct connections with the users, or it might mean adding significant value to the data before publishing it.
I started by stating that new winners will emerge in the supply of market data. The fight between liquidity providers is on and they can skirmish amongst themselves, but perhaps John Best is right - I think so. The cost associated with the distribution of data is plummeting - and its not just the bandwidth costs that are creating this lower price. New standards like XML, reusable software components and the ease of connectivity are all contributing to a very different landscape than even three years ago. The need to support a huge data-sharing network, such as the quote vendor model, is rapidly diminishing. The tools to connect directly to the marketplace are now available and affordable. Banks are realising they can buy the service rather than the box.
The end result of this shifting paradigm is that exchanges, quote vendors and banks will all in turn be forced to move up the value chain. Taking control of the data coming out of its regulated marketplace will inevitably lead to exchanges taking control of the distribution of that data. There will come a day when it will be considered archaic to have pricing on one screen and trading on another. The role too of the intermediary is already changing — simply because there are too many different marketplaces and too many prices for the quote vendors to carry them all. By getting away from the mundane price reporting, which is rapidly becoming commoditised, the price quote vendors will be able to focus on market depth information and analytic information that will actually impact trading decisions — thus moving deeper into the dealing room, and increasing profit margins.
For the banks and brokers, which are just as likely to ask exchanges for an API as a proprietary trading screen these days, a change in the nature of market data management needs to take place. In the same way that exchanges have outsourced their data publishing to data vendors, so trading rooms have allowed those same vendors to undertake much of the required management function. Increasingly, the fragmentation of services and the cost saving by buying direct will force trading management to manage their own services. They will have to take control too.
LogicScope and a few other specialist companies represent a new generation of solution providers allowing this new set of relationships to be built. The software required to take control is available, the bandwidth is cheap and there is certainly enough data. A growing number of data owners are willing to embrace the change, many who do will be winners - don't be a loser.
