Financial marketplaces are changing. Fact. The more traditional approach of pit trading within a localised community – where you might come to deposit your grain for example and ultimately take a hedge on the futures market - is in decline. However, as the evolution of our market soldiers on, it’s important to take a step back and reflect on where the exchange trading market is heading… are we really on the right track?
Over the years, the trading market has grown steadily through constant evolution and a host of reforms. However, when we look around the world today, the most effective, successful and forward-looking marketplaces are the online consumer giants such as Amazon, eBay and Alibaba. These goliaths of consumerism that we all use in our day-to-day lives unite a global network of buyers and sellers via one single platform, offering increased choice, convenience and competition to the benefit of the eco-system as a whole. So, why is this sophisticated, tried and tested paradigm not being replicated in our own business world? The truth is that the commodity exchange business is far from the levels of the consumer models. In fact, by comparison, its fair to say that it is still in a ‘primitive’ stage. Exchange trading has a lot to learn from the Amazons’ and the eBays’ of this world.
In my view, the solution is quite straightforward. The future development of the exchange community has to be the creation of what I would call a ‘liquidity network’. This ‘community strategy’ will embody the overall philosophy of working in cooperation as a pure group of exchanges, who together, can attract a community of traders and brokers. Quite simply, like my Amazon example, these traders and brokers need to have the ease of conducting their business through a single entry point to trade with multiple exchange venues.
An exchange such as ours must have a solid network of co-exchange partners to accomplish this goal. Part of this strategy would include the ‘white-labelling’ of exchange infrastructure for all the participating network exchanges across multi-commodity asset classes, clearing facilities and so on. Through this approach, those who operate via this portal have access to the key benefits of each participating exchange, providing them with an ‘open-plan’, ‘a la carte’ access option. This ultimately delivers an increased choice of contracts which boosts liquidity, but also lowers the cost of trading and execution itself.
There is no doubt in my mind that markets have become more complex and more costly to participate in. I’ve seen the downside of this over the last 18 months with banks becoming prohibited from participating in markets by regulation, with those who do stay, finding themselves challenged by more intensive capital requirements. Coupled with this, all players in the market increasingly have to invest in technology for risk management, post-trade services, give-up to clearing and indeed, more recently, for new execution services.
The underlying strategy behind this liquidity network ‘ecosystem’ is to address these issues that we as market actors all must overcome. By implementing such a system, we attempt to bring together technology and regulation to a broader set of players within the market, whilst still retaining the benefits of economies of scale and increased choice. Think of this in principle as similar to an open-source community, whereby members have universal, easy access to a certain product ‘blueprint’. As individuals within the community work to further develop the product for their own needs or for the needs of their customers, their collective development efforts become greater than the sum of their individual parts. This example further demonstrates that there is no reason for this market to be siloed or compartmentalised. We need to become a bigger, co-operative ecosystem that we will all benefit from. This is the vision behind the liquidity network.
As I mentioned previously, at its core, this is an all-encompassing strategy and its purpose is to create a next-generation platform for brokers to use to participate in the exchange ecosystem. This gives them the freedom to trade locally and deal with client relationships however they wish to. It also gives them the added benefit of using the exchange community to maintain their position within the various global regulatory frameworks that they need to conform to.
We need to bring the traders and brokers into the next generation of regulatory reform. However, the onus is on us as exchanges to create the environment which takes them to that next level. After all, traders and brokers can only function within the infrastructure available to them. Breaking down barriers sends a strong signal that we are serious in our quest to move from the existing primitive stage into a more sophisticated and advanced operating environment. In short, we need to prove the value of co-broking alongside an exchange in this ‘modern’ way. There is liquidity in this ecosystem, and where brokers and traders are struggling to get orders transacted, they should be thinking of using the exchange ecosystem to get those difficult orders done.
In terms of how we envisage the development of the market and the liquidity network as a whole is very much dependent on the interplay between our vision of an efficient market and how rules and regulations coming from the G20 reform affect this. Clearly, there has to be an appreciation that the evolution of this market is, at least partly, embedded within regulatory reform. The complex points of best execution, pre-trade risk and post-trade services are best served through tightly integrated electronic systems that can be utilised by an entire eco-system of market participants. Take MiFID II as an example. There is a whole section defining best execution and another defining pre and post trade risk management. These are overheads – a necessary but costly evil that each exchange, each broker and each trader on the market is bound by. So again, this is another benefit of bringing in this ‘community solution’ – we are all in it together, so why tackle the challenges of best execution and regulatory compliance alone?
Finally, we should think about the relevance of this liquidity network, not just in terms of established exchanges and geo-territories, but also from the perspective of emerging markets. We are already seeing exchanges in the Balkans and countries like Malaysia, India and Turkey being interested in this strategy. The formation of this exchange community means that we can provide these emerging markets with an ‘exchange in a box’ solution coupled with a good understanding of regulatory reform and how this affects these developing markets. We know that they strive to steepen their learning curve from the more established market areas such as Central Western Europe, the US and Singapore (to name a few). Rather than go through the trials of developing their market from scratch, the benefits of a ‘head start’ for the emerging markets are far more logical. This way, we can seriously ensure that the liquidity network is a truly global and homogenous one.
Richard Baker is CEO of Cleartrade Exchange