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There is no doubt about the importance of technology to an exchange's business and purpose. Events at the Tokyo Stock Exchange at the end of 2005, for example, highlighted how critical technology is to delivering market services, and the consequences of its failure.
An exchange's choices for its technology have always been clear. The world's major exchanges have invested millions of dollars in building their own trading systems, sometimes with the help of the big system integrators such as Accenture, Tata or IBM. Some exchanges have gained technology from other exchanges through strategic alliances, technology swaps, or by acquiring the other exchange. A third choice has been to buy a system from a small group of specialist exchange technology providers, including OMX Technology, Atos Euronext, Liffe Market Solutions and Computershare Markets Technology.
Over the course of 2005, moves by two of the major exchange technology suppliers significantly altered the technology landscape for exchanges:
- In July 2005, Atos Euronext, a joint venture between Euronext and Atos Origin, announced that it was merging with Liffe Market Solutions (the other IT arm of Euronext) to create Atos Euronext Market Solutions.
- A few months later, OMX Technology, the IT division of OMX and a major technology supplier to exchanges, acquired Computershare's Markets Technology group, giving OMX the largest customer base (and largest technology portfolio) of any exchange technology supplier. This move was made as part of a change in management and focus for OMX Technology, which announced that it was selling off its related banking and brokerage technology to focus exclusively on markets technology for exchanges and CSDs.
The exchange technology market is now effectively becoming a duopoly. While there are still other suppliers, none of them have close to the market share of the two new leaders, and the other players may not have the technology strength or organisational capabilities to successfully compete in the longer term, with the exception of some of the major exchanges for whom technology sales is a profit centre in its own right.
Is the result - fewer, stronger providers - better or worse for exchanges?
Lessons can be learned from other industries where duopolies exist. In enterprise business software, a duopoly is being created between SAP and Oracle, but it is too soon yet to determine the impact on the industry and how, or whether, it will benefit customers. Other obvious duopolies include Coke and Pepsi, and Motorola and Nokia.
The best lessons for the exchange industry may be gained from the example of the commercial aircraft construction industry. While smaller planes are made by a range of suppliers in different countries including the US, Canada and Brazil, the market for large commercial aircraft is completely dominated by Boeing and the Airbus consortium. The airline industry, like the exchange industry, is global, with a relatively small number of customers in many different countries, who require advanced, large-scale, and extremely reliable technology at the best possible price/performance. The duopoly situation has led to intense head-to-head competition between the two providers, forcing them into constant innovation and price reductions.
This competition appears to have benefited the airline industry as a whole: the large size of Boeing and Airbus ensures stability and economy of scale (both of them are large enough to weather short-term problems, giving customers the confidence to make long-term commitments) and the competitive one-upmanship provides customers with constant improvements in technology and in safety and general quality, as well as improved pricing.
Similarly, technology for exchanges appears to be reaching a point of maturity: the reliability and resilience of the leading trading systems are better than they have ever been, just like today's commercial airplanes. Moreover, the basic problems of designing and building an exchange trading engine have been in the main solved. All of the major technology providers, as well as the smaller providers, offer systems which implement the same core functions of order routing and order book management, common auction models and order types, market making, and supervisory controls.
While many markets still require some element of customisation (often because of the need to cater to constituencies who are bound to legacy market practices), the large global trading firms, as well as hedge funds, are pushing for standardisation in market models, order types, and interface protocols. This is one of the main drivers behind the adoption of FIX and the new FAST market data protocol by more exchanges. As exchanges standardise, the cost of change to participants is greatly reduced - and so is the switching costs for exchanges which choose to change technology providers.
The analogy with the airline industry can only be taken so far, but it is valid to this extent: exchanges in the future will rely less on specific custom functions of their trading systems and more on the overall quality and value of the service that their trading system offers. The push to standardise trading models and trading practices means that innovation needs to occur with the context of standards - innovation leaders such as the CME are showing that it is possible to adopt standard practices and models and still provide new value to the market.
There is still room of course for competitive differentiation using common platforms: the International Securities Exchange, the Boston Options Exchange, and the Chicago Board of Trade are all recent examples of exchanges which have been successful in providing participants with a unique competitive edge while using a commercial trading solution.
Choosing a technology supplier is obviously a critical decision for any exchange - it essentially places the success of a country's or a region's financial market in the hands of a technology firm. Exchange systems are expensive to buy, but even more expensive to implement: regulatory approvals, integration, testing, market rollout planning, more testing, and coordination with all of the players in the market are all expensive, time-consuming and high-risk activities. Because of the significant costs and disruption to the market caused by changing or upgrading trading systems, exchanges need to have strong relationships with strong technology providers. If their technology partners are poorly managed or under-funded, the exchange inherits these weaknesses.
The major problem for exchange trading systems is becoming one of scale: providing the scalability and performance for handling the constant increase in order and quote volumes, ensuring maximum reliability and availability from end-to-end, and guaranteeing delivery on-time and on-budget. The costs of building and supporting, and especially selling, large-scale systems to a small global customer base are very high.
Like the airline industry, these requirements are best met by larger firms with global delivery and support capabilities, financial size and stability, and a larger customer base to share the research and development costs. The consolidation of technology suppliers achieves this. Both OMX Technology and Atos Euronext Market Solutions have strong financial resources, global support and marketing capabilities, and larger customer bases (including their parent exchanges) to subsidise research and development costs.
In the short-term, the decisions made by OMX Technology and Atos Euronext Market Solutions create some uncertainty, as the two organisations must rationalise their product portfolios, successfully execute on their business integration activities, and provide a clear technical direction to their customers and the rest of the market. Both companies have announced next generation architectures, and now must offer roadmaps from their current offerings to the next generation systems.
With the acquisition of Computershare's exchange business, OMX Technology has the challenge of integrating a large number of different systems from different providers into a common product platform:
- CLICK XT, OMX's flagship derivatives trading system and now a platform for integrated trading of cash and derivatives at the ASX and Singapore Exchange;
- SAXESS, the cash trading system used by the NOREX alliance;
- X-Stream, a multi-product trading system acquired from Computershare, recently implemented by SWX and virt-x; and
- Horizon, another cash trading system installed at many smaller exchanges, also acquired from Computershare after it picked up the technology assets of EFA Software in 2002.
OMX Technology also needs to confirm whether it still makes sense to continue with its marketing relationship with Headstrong for its STRIDE technology (which Headstrong recently acquired from Elind, an Indian software provider), targeted at emerging and developing markets.
And OMX has yet another trading platform, CONDICO, for energy and commodity markets, on a different technology base.
OMX's success will hinge on how quickly and convincingly it can provide a direction which brings the best of all of these products under a common product platform and brand, and eventually a common technology architecture.
Atos Euronext Market Solutions is working on a next generation trading architecture which will integrate its two flagship products, Liffe Connect and NSC, into a single, best-of-both platform on lower-cost hardware. Like OMX, success depends on integrating the different organisations and architectures and offering a clear and compelling roadmap to its customers, including managing the transition from its existing systems to the new architecture.
Both of these suppliers have strong ownership positions with leading front office solution providers (OMX and Orc Software, Euronext and GL Trade) which further strengthens their technology positions and allows them to offer value to both exchanges and to the customers of exchanges.
What about the rest of the technology suppliers?
Assuming that both of these players are successful in their integration and consolidation, they will clearly dominate the market for exchange technology, in terms of market share, delivery capability, and R&D resources. But there will still be some options of course, for exchanges which want to consider other suppliers for their technology needs.
Exchanges which choose to build and control their own technology can continue to look to system integrators like Accenture, Tata and IBM for help. There is a role for smaller providers, such as Cinnober or Millennium IT, who can offer a technical edge or time-to-market advantage, especially for customised systems or secondary systems.
One possible area for differentiation for these providers is in low-latency trading - finding a cost-effective solution to the challenge of offering the fastest possible trading system to algorithmic traders and other heavy users of Direct Market Access. Other providers may continue to find success in specific market niches, such as patsystems, which has its matching engine installed in several commodity markets in Asia; Trayport, which leads in offering solutions for energy trading and other OTC markets; or COMDAQ, with its offerings to micro commodity markets. Low-cost providers such as Headstrong and Market Evolution may continue to find business in emerging markets and startups.
The strongest competition will likely come from other exchanges, especially larger exchanges which have already made large investments in their own technology, and can leverage their relationships and brand to sell it. Deutsche Börse has had success in selling its technology and technology-related services to other exchanges (most recently to Shanghai, in partnership with Accenture), and continues to do so where it benefits Deutsche Börse's strategic interests. Recent discussions between Euronext and Deutsche Börse open the possibility of an even stronger technology provider combining the strengths of both exchanges. London Stock Exchange has stated that it intends to expand its focus on selling technology and hosting services to other exchanges with the completion of its new technology roadmap in 2006. And BME has had success in selling its technology to several exchanges in Latin America, and may be able to continue to build on this to further expand its technology business.
Exchanges (and their technology arms, including OMX Technology and Atos Euronext Market Solutions) can, however, be constrained in how easily they can market their technology: increasingly, there is genuine competition between exchanges and in some case that competition is global. Many exchanges will not choose to be customers of their competitors.
Conclusion
The conditions appear to be in place for a competitive duopoly in the exchange technology industry - provided that the two new market leaders can effectively consolidate their positions, and remain focused on the exchange business.
In the short-term, it is important for both OMX Technology and Atos Euronext Market Solutions to realise full value from the integration of their businesses and technology, including overcoming the cultural challenges of integrating businesses in different countries. It is also important for them to provide customers and prospects with a clear path and transition plan from the products that they offer today, to their next-generation architectures. The costs of integration can be expected to have some immediate impact on their financial positions and their focus on delivery - the financial impact may be compounded by customers who may naturally defer buying decisions until a clear strategy and product transition plan is in place.
In the longer-term, an effective duopoly would seem to benefit the industry as a whole. It offers the promise of both stability and scale - more customers for fewer suppliers should result in stronger suppliers, and it is in the industry's best interests that technology suppliers are 'in for the long run'. By focusing their investments on fewer suppliers, exchanges should be able to leverage their combined R&D spending to take advantage of improvements in technology at a lower individual cost. And based on the experience of other industries, the head-to-head competition between the suppliers should also benefit customers through improved quality as well as reduced cost.
