Over the past two decades, global capital markets have changed fundamentally under the influence of rapid technological advances and a regulatory paradigm shift as a result of global financial crises. Christoph Lehl, COO, Spectrum Markets, explains the importance of resilience for trading venues.
The widespread introduction of electronic trading systems towards the end of the last century was considered a technical revolution at the time. Between then and now, there have been quantum leaps yet again. Latency times are getting ever shorter, algorithms execute automated trading strategies, from the identification of trading signals to the execution of a trade. What is more, there are new market participants on both the institutional and private side, and the interplay of all these factors has resulted in significantly increased trading dynamics.
There has been virtually an ongoing crisis situation since the end of 2019 and stock trading turnover rates and volatility naturally increase in times of crisis. However, statistics that compare the course of shareholdings and share trading over the long term clearly show that an increasing dynamism in trading corresponds to a very long-term trend and can therefore be described as systemic. According to calculations by the global stock exchange association WFE[1], the global stock market increased twelvefold between 1990 and 2020 – the global stock trading volume at the end of this observation period was around $186tn, almost 33 times as high as at its beginning.
Shorter holding periods and higher turnover rates should come as little surprise to most observers, as does the realisation that market infrastructures have to “grow” with these higher demands if they have to deal with greatly increased volumes and volatilities. In fact, many of them obviously have not yet – which seems astounding given that the trading patterns disruptions did not appear overnight. Apparently, the European markets supervisory authority ESMA[2] took a similar view in its consultation[3] on market outages from September to December of last year. There, it stated that the significant market disruptions seen over recent years had only to a lesser extent been attributable to the increase in volatility. Instead, it suspected the proprietary systems of the trading venues themselves as the most likely cause for concern in association with operating market stability.
The causes of trading failures are very similar to those factors that prove to be obstacles to the scaling of trading infrastructures, thus severely limiting their flexibility in both directions. An outdated, inflexible technology stack doesn’t just reach its limits quickly when transaction volumes explode and the market goes up and down very quickly. It can also weigh on a venue’s flexibility to swiftly adapt to new products. Conversely, a lack of flexibility will also aggravate reducing costs in periods where you employ less storage and computing capacity.
Most of the trading venues within the focus of ESMA’s market outage analysis have been in place for a very long time. While they may have overcome the era of mainframe architectures, they still exhibit monolithic designs with batch-based processes performing the data traffic. Additionally, a mix of proprietary developments and standard hardware is often hampering the migration towards more contemporary environments. Even if nominal capacities aren’t being exceeded by volume peaks and where system components interact frictionlessly, proprietary operating systems can also impose unwanted limits to operational stability, let alone their scalability and flexibility. In this context, time is not exactly alleviating things as it’s not always just proprietary architectures turning ‘legacy’ or products and processes that change – bundling the relevant human expertise needed to successfully perform large platform migrations is becoming increasingly challenging, too.
Entering into a very competitive business, highly regulated and technology-driven, means that this market will meet you with a healthy level of scepticism as the relevant players know best about the associated challenges.
IG Group, Spectrum Markets’ London-based parent company, were able to contribute their expertise to the development of Spectrum’s trading engine: expertise IG Group gained in the context of their acquisition of U.S. derivates exchange Nadex (which has been sold in the meantime). You need to plan for what you cannot plan in advance when it comes to a universe of products that can expand rapidly in terms of volume and heterogeneity. There can be members that decide to take just a fraction of the market data you generate or the market authority saying the entire market has to stop trading in a certain instrument where, as a market operator, you will want to maintain trading in all other instruments. Fluctuations in the admission to trading of instruments are a regular task though with corporate actions, new ISINs or name changes to be performed as well. The more you rely on batch processes, the higher the probability that, during the matching processes, you will end up with two different results for the same transaction.
As an MTF under MiFID II[4], with 100% uptime for over three years now, our venue has to comply with the strictest rules regarding the transparency, security and stability of its trading operations. While we can look back at a flawless performance ever since our launch, the industry as a whole can’t – which is why ESMA has proposed a number of obligations for venues to meet in relation with outages. These include setting up crisis management procedures, outlining the steps to be taken to restore orderly trading. There must be an outage strategy including necessary actions during an outage, a strategy for reopening once the problems are fixed, a communication strategy regarding the details of the outage and the way this is communicated and on how orders are treated.
While this approach is consistent with a view to the regulator’s investor protection aims, some doubts may persist as to whether it will tackle the ‘systemic’ issue of outages. When one venue is down, this will most likely occur at a time when a potential alternative venue of similar size and with a comparable representation of instruments faces similar difficulties. In such a situation, transparency is small comfort to the investor. There won’t be alternatives to an overhaul of the relevant venues’ technical trading infrastructures and with DORA[5], there will be uniform requirements for network security and information systems in the financial sector, soon.
[1] World Federation of Exchanges (WFE): www.world-exchanges.org: Statistics Portal, Annual Statistics Reports
[2] European Securities and Markets Association
[3] https://www.esma.europa.eu/press-news/consultations/consultation-paper-market-outages
[4] Directive 2014/65/EU, the Markets in Financial Instruments Directive
[5] Digital Operational Resilience Act
