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FEDERATION OF EURO-ASIAN STOCK EXCHANGES SEMI ANNUAL REPORT OCTOBER 2006 OMX Markus Gerdien President of Market Technology Modern trading systems can provide a diverse range of market models, enabling exchanges to make best use of market model development to improve transparency and facilitate growth. A CLEAR VIEW OF GROWTH In last’s years FEAS Handbook, almost all the members spoke about growing their markets as a target for the coming year. However, nearly all surveys of exchanges targeting growth show that the strategies for achieving growth are as diverse as the markets themselves. There is one factor that regularly appears in these discussions and that is the question of transparency. Indeed a number of FEAS members included increasing transparency as one of the goals that they have set for their organisations. Whilst easily discussed, transparency is not always easily explained and neither are the means for increasing it easily implemented. As a result, a brief discussion of some of the issues surrounding transparency might prove to be helpful in the context of the FEAS community. As such we will present some of the issues surrounding transparency as we have encountered them and some information about how technology can help in increasing market transparency. A Definition of Transparency In the financial markets context, information is at the heart of transparency. However it is not just a question of transmitting everything to all participants and hoping for the best. It is the quality, timeliness and trust that participants have in the information, as well as the instruments (companies or products) to which the information relates, that determines the transparency of a market. In addition to the transparency of information it is the transparency of the market structure itself that has an important bearing on the attitude of the participants toward the market as a whole. Transparency incorporates perceived and actual risks facing participants in the market since these risks will impact a participant’s willingness to trade. For example, it is possible that a market with full anonymity of orders and a low level of settlement risk (say a fully cleared market) can be more transparent than a market where the identity of the participants is known. This is because in the former market, a participant entering into a trade can be confident that the price displayed in the system is the true price of the deal in which they are about to engage. The price is transparent. Measuring Transparency We have seen that there are a number of factors that affect the transparency of a given market. However, finding a direct, objective metric for measuring transparency is difficult. A number of metrics are correlated with transparency, for example liquidity (as measured by the tightness of the bid offer spread for example) or settlement risk. Even factors such as foreign investment provide a measure of the confidence of participants in the transparency of the market. But it is difficult to evaluate these metrics across markets. As a result, it is necessary to focus on means by which we can improve individual factors affecting transparency and make comparisons within the market as these changes have their affect on trading. Increasing Transparency We can look at a number of different approaches to improve individual transparency factors but for the purpose of this article we will focus on the issues of technology and market structure. Transparent Benefits We started this discussion with the premise that growth is enhanced by transparency. Whilst that is true there are some more concrete benefits that derive from increased transparency; • Liquidity • Cost Control • Risk Management Increased Liquidity Increased confidence in the reliability of a given market, its transparency, will encourage participants to enter orders into the system. In a transparent market members will be willing to enter orders that will stay in the order book, increasing the depth of market information. This allows the market to show the overall interest in the market, not just the bid and offer price. The increase in liquidity brings a commensurate tightening of the bid offer spread, thus decreasing the “cost” of execution by narrowing the gap that a participant must cross in order to achieve execution. Direct Control of Transaction Costs In addition to the reduction in execution costs from a tighter bid offer spread, a transparent market allows a participant to understand the true cost of execution. This because the cost of information not only includes fees and charges, but also makes the risk of settlement failure, or the number of “fills” required to complete a given order, transparent to the participants. Risk Management One of the transaction costs that are more clearly defined in a transparent market is the impact of risk in the system. Whether it be a fully cleared market or an OTC market with clearly defined limits, the improved access to risk information makes the true cost of a transaction more readily determined. Indeed the total amount of risk should be decreased, since the factors affecting failure can be reduced. PAGE 16
FEDERATION OF EURO-ASIAN STOCK EXCHANGES SEMI ANNUAL REPORT OCTOBER 2006 Increasing Transparency Trading Model A wide variety of market model features can assist in facilitating transparency. These include; • Market Makers to guarantee the availability of a buyer and seller; • Strategy Trading in derivative markets to improve liquidity particularly by spreading calendar interest in different expiry dates for the same commodity or instrument; • Clearing and/or Central Counter Party to provide a guaranteed settlement; and • Credit and/or Position Keeping to control the overall exposure of participants to the market as a whole or each other. Modern trading systems can provide a diverse range of market models, enabling exchanges to make best use of market model developments to improve transparency and facilitate growth. Technical Infrastructure Regardless of the market model there are features of the technical infrastructure of an exchange that can help increase transparency. These include; • Information Dissemination in a timely and reliable fashion to support true price discovery; • Absolute Throughput, removing “bottlenecks” in the system that reduces the overall transparency of the market by impeding a participant from acting on a price that they see; • Responsiveness and Latency, determining the speed with which a participant can respond to opportunities in the market and directly affecting the willingness of the participants to commit their orders to the system; and • Reliability, which is the cornerstone of a transparent market since without it there is no trust and without trust information cannot truly be transparent. Efficient Securities Transactions There are always structures to simplify, systems to revolutionise, transactions to accelerate and markets to connect. From Singapore to New York and from Sydney to Helsinki, transparent markets powered by OMX solutions are up and running 24 hours a day, 7 days a week, 365 days a year. A world leading expert in the exchange industry, OMX delivers comprehensive solutions that connect markets, improve efficiency and, ultimately, increase the competitiveness and profitability of exchanges, clearing organizations and central securities depositories around the world. About OMX OMX is a leading expert in the exchange industry. Through the Nordic Exchange in Copenhagen, Stockholm, Helsinki, Riga, Tallinn and Vilnius, OMX offers access to approximately 80% of the Nordic and Baltic securities market. Our integrated technology solutions span the transaction chain enabling efficient securities transactions. With more than 60 customers in over 50 countries, OMX is the world’s foremost provider of marketplace solutions for exchanges, clearing organizations and central securities depositories. OMX is listed on the Nordic Exchange in Stockholm, Helsinki and Copenhagen. For more information please visit www.omxgroup.com. No. 1 in marketplace solutions Widely known for our electronic trading platforms, OMX provides world leading technology solutions across the transaction chain. Our systems and services are designed to help exchanges, clearing organisations and central securities depositories meet the extreme demands of the securities industry with efficiency and flexibility. OMX leverages its expertise to develop solutions that are in sync with today’s fast evolving financial markets and changing technology standards. We offer systems, systems support, operational services, and advisory services that promote efficient securities transactions. Our broad experience also enables us to offer complementary services, such as business analysis, benchmarking and implementation support. Exchanges OMX provides systems that support everything from traditional equity trading to the most complex derivatives trading, and can handle multiple asset classes such as currencies, fixed income instruments and commodities on a single platform. OMX also offers outsourcing and advisory services to help customers secure and develop their business. Today OMX is the world’s largest exchange operator in terms of number of operating hours. Clearing organisations and CSD’s OMX offers systems for clearing derivatives and cash-traded securities as well as systems for settlement and book-entry within central securities depositories. The systems handle administration of several asset classes such as currencies and different types of fixed income products and commodities. OMX’s offering also includes advisory services and outsourcing of applications and infrastructure. CONTACT INFORMATION Contact Name Mr. Adam Kostyal E-mail adam.kostyal@omxgroup.com Website www.omxgroup.com PAGE 17
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