New technologies are disrupting the financial sector
The advent of digital technologies has renewed and reshaped the financial landscape. Today, securities are traded primarily through computer programs that react in nanoseconds (faster than a human) to the smallest fluctuations in the market.
On the sell side, the constitution and liquidation of securities portfolios has undergone major changes over the last fifty years, mainly due to the computerization of transactions and the recent emergence of big data. The famous scenes of brightly dressed brokers jostling each other, waving their hands feverishly and shouting their orders on the stock market are now a thing of the past, although they are sometimes still repeated for marketing purposes.
Two new types of technology
“Electrification” of stock exchange transactions is based on at least two types of technologies. First, exchanges have automated the process of matching buyers and sellers of securities. For example, let’s say you want to buy 1,000 L’Oréal shares. Your bank or broker will then place your order through Euronext, one of L’Oréal’s listed markets. Euronext continuously receives, buys and sells such orders, matching them using computers and algorithms.
This is already a radical change, but you should know that Euronext also collects a lot of information about orders placed, transactions carried out… which can then be sold to other intermediaries and investors. In this respect, trading platforms are increasingly similar to other digital platforms such as Facebook, Google or Twitter, and their share of revenue from data sales is increasing dramatically (+13% per year since 2012).
The second type of technology refers to the automation of decisions by sector players to buy or sell securities. It is called using algorithms to make portfolio decisions algorithmic trading. Thus, in a single day, an asset manager can buy or sell millions of shares of a given security in response to the inflows and outflows of investors from his fund. This automation process is similar to other industries where humans are replaced by machines.
Some companies specializing in high-frequency trading use algorithms based on extremely fast access to data (less than a millisecond), especially market data sold by electronic trading platforms. With privileged access to this information, these companies can take advantage of small price differences for the same stock between the two platforms. Some of them even pay to have their computer servers located near their trading platforms or even rent space in the same room to save a few precious nanoseconds, which can make all the difference in the transmission of information.
The impact of these developments on the trade costs of other market participants is a controversial topic and raises many issues that are at the center of political debate in the European Union and North America today.
Rules must be made
Various national bodies, such as the European Securities and Markets Authority (ESMA) and the Autorité des marchés Financiers (AMF) in France, are the main regulators of securities markets in the EU. The Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) covers the American markets.
A number of issues related to the impact of new technologies need to be investigated by these institutions. For example, does the electronicization of financial markets really reduce the costs of building and liquidating portfolios for investors? Thus, investors can get higher returns on their savings. Is algorithmic trading making financial markets less or less stable? Do trading platforms have too much weight in evaluating market data?
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In our recent research article, we also ask the question of whether trade should slow. The problem is that high-frequency traders can make excessive profits at the expense of other participants.
Some platforms have less stringent transparency requirements than major exchanges, which can be a concern. The volume of so-called “dark trading” (private trading networks) is increasing and currently accounts for around 40-50% of share trading in the EU, which calls for more stringent regulation of “dark pools”. . Finally, there is the question of the extent to which algorithms risk destabilizing financial markets and leading to strong price fluctuations.
What the future holds
In the coming years, the economic model of exchanges should therefore rely more heavily on the monetization of trading data. There may then be some competition between trading platforms to attract users who generate this data, as the tech giants do.
This trend, which has accelerated during the Covid-19 pandemic, will, if it continues, put intense competitive pressure on brokers and ultimately lower trading costs for investors. Perhaps someday the data generated by transactions will pay more than the transactions themselves. So it may be that at some point trading platforms need to do more to attract users, such as paying you to post your trades there, just to use them and generate more data. !