Increasing competition and fragmentation among exchanges is creating a ‘speed race to zero’ as exchanges increase their investment in technology to handle an ever-increasing data flow and attract investors such as high frequency traders, according to a research note by Norges Bank Investment Management, manager of the world’s largest sovereign wealth fund.
‘We view the current latency race as ultimately a dead-end,’ Norges says. ‘Modern markets required the speed-up that computer technology and automation provided to exchanges, since it enabled increased competition and lower trade execution costs. However, we are now reaching a point where further latency reduction is both extremely costly and potentially counter-productive. The race to zero is almost over.’
Norges says the number of listings has decreased in recent years even as trading volumes increase, with listings in the US falling by about 20 percent between 2003 and 2014 and dropping by about 30 percent on Europe’s Euronext and Deutsche Borse. At the same time, buybacks and mergers and acquisitions have been reducing free float by about 4.5 percent a year in recent years.
‘While there has been consolidation and a drop in the number of exchanges in developed markets, we have not seen a concentration in liquidity,’ Norges writes. In fact, it says ‘the opposite is true – the increasing number of off-exchange trading venues has led to fragmentation in liquidity and greater complexity in order routing processes.’
The fund manager says the US now has 11 equity exchanges and more than 60 alternative trading platforms. Many large exchanges are now developing their own off-exchange trading platforms and dark books themselves to meet growing demand from institutional investors, Norges says.
‘Fragmentation and increased competition have led to some worrying developments for exchanges, broker-dealers and investors alike,’ Norges says. The exchanges ‘must adapt and innovate to enhance their attractiveness to institutional investors who have supplanted the many small retail investors that exchanges were originally designed to serve.’
