Lars Ottersgård
Senior Vice President
NASDAQ OMX Market Technology

Not surprisingly, coping with the unprecedented change in the financial markets in the last couple of years has been a significant challenge. Adding to the burden is the global financial crisis.

Clearly, we are facing difficult times. But, as an industry, we have an opportunity to learn from this experience and build stronger markets.

This perspective emerged from the Technology of the Future (ToF) forum held in Stockholm in mid-November 2008. Every 18 months or so, NASDAQ OMX hosts ToF for our exchange and marketplace customers. The two day event combines thought leadership from industry luminaries with specific updates from NASDAQ OMX on technology planning and other business efforts that can benefit the industry. The theme of ToF 2008 was fittingly entitled “Opportunities in Change.”

Conference delegates agreed that the lack of transparency and central counterparty clearing services led to tremendous market risk. If exchanges played a greater role in the OTC derivatives markets, the crisis would not have been as severe. This logic has led regulators to conclude that exchanges and clearinghouses must be part of the response to this problem. And technology is the backbone of any marketplace solution.

Recent experience has shown that a particular counterparty’s credit- worthiness can deteriorate quickly, and end-of-day risk calculations are no longer sufficient. Ideally, risk should be calculated intra-day – or better yet, in real-time – to ensure customers have posted sufficient collateral before being allowed to send in orders. Exchanges can look for ways to leverage their technology to calculate intra-day risk. When a customer sends in an order, the system can automatically validate the firm’s collateral and filter out bids and offers from unacceptable counterparties. Exchanges can earn revenues from this service while ensuring the integrity of the financial markets.

ToF delegates noted that the potential to generate revenue through the sale of market data has not yet been fully exploited. UK-based PLUS Markets, which caters to investors in small-to mid-cap equities, has a unique business model in which it earns its revenue on market data, not on transaction fees. Exchanges can package data specifically for certain segments of the market such as compliance departments and regulators. And exchanges can build interfaces to offer market replay services for dispute resolution, as NASDAQ OMX has recently done.

The industry is still coming to grips with the concept of best execution as mandated by MiFID and Regulation NMS. In the US, it is simply transacting at the lowest price available at a given time. But in Europe best execution takes into account an array of factors including clearing fees, the cost of latency and spreads. No doubt compliance departments would welcome a solution from exchanges that can help with this analysis.

Exchanges also have an opportunity to diversify and generate new revenue through partnerships with niche exchanges. For example, NASDAQ OMX has taken a minority investment in Agora-X, a technology customer that has developed an institutional ECN for OTC commodities contracts.

Market structures have changed, and the environment is far more competitive than a decade ago. Financial instruments are traded 24/7. Exchanges must think globally and adapt to international ways of trading, clearing and handling market data. They need to make acquisitions or link into partners’ networks to tap into the broadest possible customer base. And if we learned anything from the financial crisis, it is that risk management must be a top priority. Yes, all this is challenging, but optimists see the current crisis merely as another opportunity to strengthen their business model.