Howard Frank, dean of the Smith School of Business welcomed attendees.

Characterized by expanded access, rapid and ubiquitous trading, reduced reliance on physical marketplaces, today’s financial markets represent both globalization and consolidation of markets in an ever-changing environment. On April 27, 2007 distinguished members of the finance community and renowned scholars from the University of Maryland's Robert H. Smith School of Business finance and decision and information technology faculty gathered to assess the forces driving change in financial markets at the Smith School's Seventh Annual Netcentricity Conference.

Howard Frank, dean of the Smith School of Business, in his welcome to attendees, discussed his personal involvement with the NASDAQ’s original computer system, and the immediate and immense increase in traffic and load it experienced when it went live. “As soon as people get a chance to use an instrument that makes their work more efficient and effective, they use it,” he said, referring to the rapid proliferation of technology in every sector of business.

The keynote speaker was Samuel Gaer, chief information officer of New York Mercantile Exchange, Inc. (NYMEX).

Rise of the Machines
Keynote speaker Samuel Gaer, chief information officer of New York Mercantile Exchange, Inc. (NYMEX),gave a sweeping historical overview of the rocky course of technology adoption in the finance industry. He traced the development of modern trading technology from the time of the 1987 stock market crash, a watershed event that indirectly resulted in the rise of the modern day-trader. Gaer discussed the disruptive effects of technology and the way it changed the trading landscape.

The biggest change in the last few years has been the migration from primarily floor-based trading to electronic trading. On a global basis, more than 50 percent of trading is done electronically, and Gaer reports that on some days NYMEX conducts almost 80 percent of its trades electronically.

Today’s trading floor is bristling with formidable technology, from dense wireless networks to real-time trading software to a complex distributed infrastructure. But Gaer says that technology is becoming key to the future success of the finance industry. “Finance used to be a very non-tech business, but lately a spectacular change has taken place,” said Gaer. “Millions of dollars hang on a company’s ability to have a millisecond advantage over its competitors.”

To achieve this advantage, the industry is pushing the physical limits of technology, with exchanges measured not just in milliseconds but microseconds. Gaer predicted a “rise of the machines,” as algorithmic trading systems programmed by humans begin to replace flesh-and-blood traders.

Albert “Pete” Kyle, Charles E. Smith Professor in Finance, Smith School

Michael Richter, executive vice president of development at Lime Brokerage, LLC

Vasant Dhar, professor and head of information systems at NYU's Stern School of Business

Robert L.D. Colby; deputy director at the U.S. Securities & Exchange Commission's Division of Market Regulation

Speakers & Panels
Albert “Pete” Kyle, Charles E. Smith Professor in Finance, spoke about the economic and financial theories behind these new fast markets. Kyle, one of the world’s preeminent experts in the economics of financial trading, related today’s networked markets to the cotton farmer’s marketing cooperative operated by his father in West Texas in the 1970s. It was an early electronic market networked by phone lines and a bulky IBM 360; the market connected far-flung cotton gins and cotton farmers and involved a simple auction system similar to eBay. So the technology to create electronic fast markets have been in existence for decades, said Kyle, but only recently have financial markets become computerized.

In looking at the history of the computerization of financial markets, Kyle discussed several seminal papers over the last 30 years that shed light on the financial theories behind current market behavior.

Kyle also discussed the changes in recent financial markets and pondered the differences between the market’s old profit model, which is a mutualized private club where member traders make profits from a playing field weighted in their favor, to the recent development of demutualized public companies. “Electronic exchanges may be able to realize significant cash flow from low fees charged to active electronic traders,” said Kyle. “Huge volume with low fees could be a profit model that works.”

Michael Richter, executive vice president of development at Lime Brokerage, LLC, spoke on algorithmic trading and its impact on electronic markets. Vasant Dhar, professor and head of information systems at NYU's Stern School of Business addressed the question, "Has the transformation in financial services already
happened?"

Robert L.D. Colby; deputy director at the U.S. Securities & Exchange Commission's Division of Market Regulation, discussed the challenges of regulating fast markets. Colby gave three reasons why we need market regulations: externalities in the market (individuals have a propensity to take on more risk than is beneficial, he explained);  market opportunities on an individual basis can't achieve the same benefits as on a societal level; and to preserve competition.

Bruce Weber (left), professor and area chair at London Business School.

Albert "Pete" Kyle, Smith Chair Professor of Finance, Karen Furst, policy analyst with the Office of the Comptroller of the Currency, and Joel Hasbrouck, Kenneth G. Langone Professor of Business Administration and professor of finance at NYU's Stern School of Business.

Panel Discussions
The conference played host to two panel discussions. Bruce Weber (left), professor and area chair at London Business School, and Hank Lucas, Smith Chair in Information Systems at the Smith School, tackled the topic, "How Long Can Technology Postpone the Inevitable: The NYSE Moves to an Electronic Market."

In the afternoon panel, Karen Furst, policy analyst with the Office of the Comptroller of the Currency, Joel Hasbrouck, Kenneth G. Langone Professor of Business Administration and professor of finance at NYU's Stern School of Business, and Albert "Pete" Kyle, Smith Chair Professor of Finance, took on "The Consolidation and Fragmentation in Financial Networks."

Hasbrouck said, electronic markets are transparent, and order interactions are increasingly blind. The cancellation rate is increasing -- 40 percent of orders are pulled within two seconds;  there is a weak desire to trade and no strong expectation that orders will execute. Albert "Pete" Kyle, said that the next generation of development will be a customer trading algorithm for before the order gets generated -- services to automate order placement strategies. For example, explained Kyle, my 20 customers can trade with each other before they hit the trading floor.

Hank Lucas, a co-chair of the conference and Robert H. Smith Chair in Information Systems.

Conclusions
There is a migration of major exchanges from floor to electronic trading -- almost every major exchange is 75 percent electronic (NYSE hybrid 70%, CME 76%, CBOT 80%, NYMEX 80% - peak). Markets have to move or lose their franchise, summarized Hank Lucas, a co-chair of the conference and Robert H. Smith Chair in Information Systems. You can use technology to support an existing business model, but can’t stop an overwhelming technological disruption, said Lucas.

The impact is more transparency, less biased markets, and higher volume trades as traders move down the demand curve: high elasticity. The business model for an exchange is changing. As traders trade more aggressively, the market becomes more efficient, but not perfectly so, and exchanges can make money on volume at a low cost. Virtual market makers provide limited information and quickly abandon the market.

The contrarian view states that existing business models of financial services firms are not at risk. Major firms are building trading floors to have traders all in one place with face-to-face contact. Any transformation is in the markets, themselves. One challenge is interoperability and the number of players involved in a trade.

Lucas wrapped up the conference saying he believes that financial markets have indeed been transformed by information technology. "However," said Lucas, "One man's transformation is another's incremental change."

▓ Rebecca Winner, Alissa Arford-Leyl, Office of Marketing Communications
Photos by Vipul Bajpai