Trading Automation and Developing Equity Markets

World Bank Finance Forum 2002

June 21, 2002

Dr. Benn SteilCouncil on Foreign Relations

The Impact of Trading Automation

Trading costs

Cost of equity capital

US vs. Europe

Exchange governance and business strategy

Implications for developing equity markets

Automation and Trading Costs

39

28

80

54

0

10

20

30

40

50

60

70

80

basis points

NYSE Nasdaq

Traditional Brokerage Nonintermediated Systems

Source: Domowitz and Steil (2002)

Data Source: Large US mutual fund, 1992-1996

Automation and Trading Costs

28

33

24

26

28

30

32

34

%

NYSE Nasdaq

Savings through Disintermediation

Source: Domowitz and Steil (2002)

Data Source: Large US mutual fund, 1992-1996

Automation and Cost of Capital

-53-17

-8 -2.6

-60

-50

-40

-30

-20

-10

0

% Change

Trading Cost Cost of Capital

US, 1996-1998 Europe, 1996-1998

Source: Domowitz and Steil (2002)

Automation and Cost of Capital

-30

-50

-4 -7.8

-50

-40

-30

-20

-10

0

% Change

Trading Cost Cost of Capital

US Fully Automated, est. Europe Disintermediated, est.

Source: Domowitz and Steil (2002)

Trading Costs: US vs Europe

37 38

7

31

30

7

0

10

20

30

40

basis points

Total Explicit Implicit

1996-1998

US European Continent*

*France, Germany, Italy, The Netherlands, Spain, Sweden, Switzerland

Source: Domowitz, Glen and Madhavan (2001)Domowitz and Steil (2002)

Automation and Exchanges

•Trading systems

•Access

•Pricing

•Revenues

•Governance

Demutualized Exchanges

Completed Demutualizations

• Stockholm Stock Exchange (1993)• Tradepoint / virt-x (never mutualized) (1995)• Helsinki Stock Exchange (1995)• Copenhagen Stock Exchange (1996)• Amsterdam Exchanges (1997)• Borsa Italiana (1997)• Australian Stock Exchange (1998)• Iceland Stock Exchange (1999)• Athens Stock Exchange (1999)• Stock Exchange of Singapore (1999)• SIMEX (1999)• LIFFE (1999)• Toronto Stock Exchange (2000)• Sydney Futures Exchange (2000)• New York Mercantile Exchange (2000)• Hong Kong Stock Exchange (2000)• London Stock Exchange (2000)• Deutsche Börse (2001)• Oslo Exchanges (2001)• Euronext (2001)• ArcaEx (never mutualized) (2002)• International Securities Exchange (2002)

Agreements or Board Proposals for Demutualizations and Public Offerings

• Bolsas & Mercados Espanoles• Chicago Board Options Exchange• Chicago Board of Trade • Chicago Mercantile Exchange• International Petroleum Exchange• London Metal Exchange• Nasdaq• New Zealand Stock Exchange• Nymex• Swiss Exchange• Tokyo Stock Exchange

Automation and Exchanges

• Trading systems

• Access

• Pricing

• Revenues

• Governance

• Consolidation

Exchange Mergers and Alliances: 1997-2002

Exchange Mergers AEX: Amsterdam Stock Exchange and European Options Exchange I HEX: Helsinki Stock Exchange and SOM I BEX: Brussels Stock Exchange and BELFOX I OM Stockholm Exchange: Stockholm Stock Exchanges and OM I Wiener Börse and ÖTOB I Pa ris Bourse and Monep I Paris Bourse and MATIF I Borsa Italiana and MIF I Eurex: DTB and SOFFEX I Nasdaq and AMEX I NYBOT: Coffee, Sugar & Cocoa Exchange and NY Cotton Exchange I Singapore Exchange: Stock Exchange of Singapore and SIMEX I Euronext: Paris, Amsterdam, Brussels, and Lisbon exchanges I virt -x: Tradepoint and Swiss Exchange (blue chip equities) I Archipelago ECN and P CX equities I LIFFE and Euronext I NASD AQ and EASDAQ I Johannesburg Stock Exchange and South African Futures Exchange I HEX and Tallinn Stock Exchange A Hong Kong Stock Exchange and Hong Kong Futures Exchange A Bovespa (Brazil) and BVRJ A International Petroleum Exchange and Intercontinental Exchange A Chicago Board of Trade and Chicago Board Options Exchange N MATIF and MEFF N Alberta Stock Exchange and Vancouver Stock Exchange N Lisbon Stock Exchange and Oporto Derivatives Exchange N Eurex Bonds and EuroMTS N Leipzig Power Exchange and Eu ropean Energy Exchange N Barcelona, Bilbao, Madrid and Valencia exchanges N Kuala Lumpur Stock Exchange and MESDAQ N HEX and Riga Stock Exchange N Common Trading System Oslo Stock Exchange and OM (derivatives) I FUTOP (Denmark) and OM (derivatives) I Norex: OM Stockholm Exchange and Copenhagen Stock Exchange I Deutsche Börse, Wiener Börse, and The Irish Exchange I Eurex and HEX I Chicago Board of Trade and Eurex I NEWEX (central and eastern European equities): Deutsche Börse and Wiener Börse I Euronext and Warsaw Stock Exchange I Norex and Oslo, Reykjavik, Tallinn, Riga, and Vilnius exchanges A

Key: I=implemented A=agreed N=being negotiated

International Pet roleum Exchange and Nord Pool A Globex Alliance: Chicago Mercantile E xchange, MATIF, MEFF RV, Singapore, Montreal, and BM&F (Brazil) A Paris Bourse and Au stralian Deri vatives Exchanges A Euronext and Bourse de Luxembourg A LIFFE and TIFFE A London Stock Exchange and Johannesburg Stock Exchange A Chicago Mercantile Exchang e and Nymex (energy contracts) A

Common Access System MATIF and MEFF RV I Chicago Mercantile E xchange and LIFFE I Lisbon Stock Exchange and MEFF I Euro -Globex Alliance : MATIF, MEFF RV, and MIF A SWIFT-FIX access protocol: Amsterdam, Br ussels, Frankfurt, London Madrid, Milan, Paris, and Zurich A

Strategic Alliance/Joint Venture Benelux exchanges I Globex: Chicago Mercantile Exchange and MATIF I Cantor Financial Futures Exchange: Cantor Fitzgerald and N ew York Board

of Trade I MITS: London Metal Exchange and MG I OM Gruppen and NGX I Nasdaq Japan: Nasdaq and Osaka Securities Exchange I Nasdaq and Hong Kong Stock Exchange I Chicago Board Brokerage: Chicago Board of Trade and Prebon Yamane I OneChicago (joint venture among CBOT, CBOE and CME) I Nasdaq and Australian Stock Exchange A NYMEX -SIMEX A Paris Bourse, Swiss Exchange, Borsa Italiana and Li sbon Stock Exchange A London Stock Exchange and Buenos Aires Stock Exchange A Nord Pool and Leipzig Power Exchange A Australian Stock Exchange and Singapore Exchange A GEM: Amsterdam, Australia, Bovespa (Brazil), Brussels, Hong Kong, Mexico, New York, Paris, Tokyo and Toronto exchanges A Tokyo and Toronto exchanges A Nasdaq and LIFFE A Euronext and HEX A Chicago Mercantile Exchange and Cantor Fitzgerald N International Petroleum Exchange and NYMEX N Eurex and NYMEX N Chicago Board Options Exchange and Osaka Securities Exchange N LIFFE and Boston Stock Exchange (options trading) N

Implications for Developing Equity Markets

•Trading systems : market architecture

•Trading systems: build vs. buy

•Access

•Exchange governance

•Foreign ownership

•Post-trade systems

Trading System Operator

CSD Operator

Exchange

National Payments System

Computer Operations

Computer Operations

Implications for Developing Equity Markets

• Trading systems : market architecture

• Trading systems: build vs. buy

• Access

• Exchange governance

• Foreign ownership

• Post-trade systems

• Regulation of market functions: the case of listing