Technology is Driving Opportunities for Exchanges

Exchanges have encountered an enormous amount of change in the last several years. A major catalyst has been the spate of new regulations that fragmented our market structure, exposed us to new types of risks and opened the door to new opportunities such as central clearing. 

Technology advancements have also created tremendous change in the exchange and financial services landscape.  

A combination of regulatory and technology trends, focused on automation and standardization, have created an explosion of data throughout the financial industry. According to International Data Corporation (IDC), the world generated about 8 trillion gigabytes of data in 2015, and by 2020, we could be generating as much as 40 trillion gigabytes of data in a given year. Exponential advancements in technology over the past several decades, thankfully, have resulted in much lower storage costs. On the positive side, the storage cost of data has dropped like stone. The cost of data storage was about $10 per gigabyte in 2002, but nowadays Google and Amazon charge about $.03 per gigabyte. Storage is so cheap that it’s provided the ability to generate collect, and store ever increasing amounts of structured and unstructured data.

Another major industry trend has been centered on the "need for speed".  In fact, much of the technological innovation specifically in the exchange space over the last decade has been around speed and connectivity resulting from the automation of trading decisions. Some say the markets are fast enough, and our clients are no longer demanding lower and lower latency. That’s probably true across many markets, but now clients are asking us for deterministic speed. Exchanges may be able to execute orders end to end in 5 microseconds, but a burst of volume or stressed volume can potentially increase the latency to 50, 100 or 200 microseconds. Our clients can’t plan for that, and they’re trying to figure out how to interact with exchanges and size their systems.

A third major trend has been the globalization of capital markets, enabled by advanced global networks, the globalization of financial institutions, and further fueled by mobile technology.  Investors today expect to be able to invest in any asset class anywhere in the world.  A US retail investor can log into an online brokerage account and trade equities, currencies, fixed income, and commodities from almost any marketplace in any geography.  If an average retail investor can do that, imagine how advanced the strategies and investment decisions are for institutional investors managing billions of dollars.  For example, a country as far away as Indonesia receives $30 billion in foreign direct investment each year.  The markets are all interconnected and globally correlated today.  

So, what are the technology trends that will shape exchanges going forward?  In my opinion, five areas of innovation should be on their radar screens that could have an incremental impact or even a disruptive impact on the industry in the future.

1. FPGA

With FPGA technology, software is embedded on hardware to allow much more deterministic speed. Clients have a steadier experience regardless of bursts of volume and stressed environments. This major innovation is helping us to drive through change seamlessly, reduce friction and shift from microseconds to nanoseconds.

2. Mobile Technology

The continued, global proliferation of mobile technology throughout the developed and developing economies is fundamentally changing consumer behavior. Consumers are increasingly buying goods and services on their mobile devices, which is having a significant impact on brick and mortar stores. In fact, mobile technology is allowing  developing countries to skip a whole generation of retail. In our industry, investors have access to the financial markets from anywhere. Even in the most remote areas of the world, people can log onto a mobile device, check prices, execute transactions and hedge their exposure. That’s a very powerful proposition, particularly in the developing world.

3. Cloud Computing

According to some estimates, cloud providers will generate half a trillion dollars in revenue in the next few years. As FPGA comes into the cloud, it allows us to think about whether we can operate our markets in the cloud. Do we need to have servers in our data centers, or even in our own country? Is the cloud more secure than our data centers? Can we have essentially have a market-on-demand environment that will allow for the level of speed and connectivity we require, and reduce our infrastructure costs significantly?

We believe the answer is yes, and Nasdaq is starting to look at how we use the cloud and develop our proof of concepts. Today we have an entire infrastructure supporting our data sandbox in the Amazon cloud. In addition, our new investor relations portal, which is used by thousands of investor relations professionals worldwide, has been built entirely in the cloud. This is a significant technology advancement that could have a huge impact in the markets.

4. Machine Intelligence

Market efficiency is undermined partially by factors such as the herd mentality and frictions with our technologies. But consider a future in which machines can take a massive amount of data and process it, draw conclusions, make investment decisions and execute at a snap of a finger. It’s amazing to think what machines might do to transform our markets. That being said, we need to be careful not to downplay the potential risk. Exchanges, broker dealers, and investors alike will need to be extremely vigilant and sophisticated in surveillance (another area moving towards machine intelligence) to ensure that a bad piece of data that ventures into the system doesn’t throw the markets into chaos. 

In my opinion, we must never lose sight of the fundamentals ultimately driving the underlying value of an asset, despite the existence of massive amounts of macro and meta data that could skew investment decisions away from fundamental drivers.  Whether it is machines or humans processing the information and forming investment decisions, a long-term focus on fundamentals has been the proven way to capture value.

5. Blockchain

Lastly, blockchain technology could be particularly disruptive in the post-trade environment, in bilateral trading, and in other elements of the financial ecosystem.  We think this technology can create an end-to-end solution that streamlines the entire trading, clearing and settlement process, create a perfect record of ownership, and allows the transfer of the securities and cash in a more frictionless way. In some respects, the technology is the easy part. Creating the legal framework and ecosystem to support it and the commercial strategy will be far more of a challenge.

Our early work with the blockchain has focused on areas that surround the actual trade. For instance, Nasdaq has been experimenting with an implementation in Estonia to enable proxy voting using blockchain technology and capture a perfect record of ownership. In the Nasdaq Private Market (NPM), we’re using blockchain to manage cap tables, which can be quite complex as private companies raise rounds of financing, issue equity and sort out all the special terms and rights in the process. We’ve developed an end-to-end workflow tool, known as Nasdaq LINQ, which allows issuers to post due diligence documents and allow only certain people to see them. Then we have a layer on top of our NPM transaction processing system that enables participants to trade and transfer securities and related funds through the blockchain.  As we gain more experience with the technology we have several additional areas where we are creating working proofs of concepts that get closer to public market trading environment.  The future of the blockchain is unknown, but the potential is tremendous.

There’s a lot to be excited about in technology right now. Not all of us will implement these new innovations simultaneously; we will likely make the investments when the time is right for our individual marketplaces. But exchanges will need a new generation of technology to form the foundational platform to take advantage of the emerging trends. That’s why we are developing and deploying the Nasdaq Financial Framework for ourselves and our exchange customers. It’s flexible and open, so it integrates with our new and existing systems as well as third party solutions. We see it as an innovation engine that can support evolutionary and revolutionary change to enable exchanges to march into the future with confidence.

For more on these topics, watch my talk at Nasdaq's Technology of the Future (ToF) Conference: