U.S. capital markets typically define how
the rest of the world markets operate; more financial investments are
made in the U.S. than in any other country. But this supremacy hasn’t
always translated to leading business and technology practices. There
are situations where U.S. markets are lagging behind or have operated
with known issues, and it’s important to understand where the pitfalls
are/were:
Decimalisation of stocks – Unlike other markets, U.S. stocks were quoted in fractions (e.g. price of stock XYU is $4 1/16 instead of $4.18) instead of decimals until 2001. A quote in fractions results in market inefficiency, higher costs and price manipulation.
Quote driven exchanges – Most exchanges in the world moved to order driven exchanges in the nineties; while U.S. exchanges moved to hybrid exchanges which are both quote and order driven only in the last 10 years. In an order driven exchange, a computer matches “buy” and “sell” orders making it efficient and transparent, though it has a downside of not matching low liquidity stock orders.
Fixed income trading – Fixed income trading in the U.S. is still dominated by voice/fax or mail which leads to higher price spreads and less transparency. In the world of the Internet with well-connected marketplaces, it is propitious to have trading done on an electronic platform in an automated and efficient manner.
Listed derivatives trading – In listed derivatives trading there is still an unresolved risk in the system as clients could be crossing their limits while trading through an executing broker
Settlement period – In the U.S. the settlement period for equities is three days after the trade date. This extended period doesn’t have a strong technical or functional rationale.
Decimalisation of stocks – Unlike other markets, U.S. stocks were quoted in fractions (e.g. price of stock XYU is $4 1/16 instead of $4.18) instead of decimals until 2001. A quote in fractions results in market inefficiency, higher costs and price manipulation.
Quote driven exchanges – Most exchanges in the world moved to order driven exchanges in the nineties; while U.S. exchanges moved to hybrid exchanges which are both quote and order driven only in the last 10 years. In an order driven exchange, a computer matches “buy” and “sell” orders making it efficient and transparent, though it has a downside of not matching low liquidity stock orders.
Fixed income trading – Fixed income trading in the U.S. is still dominated by voice/fax or mail which leads to higher price spreads and less transparency. In the world of the Internet with well-connected marketplaces, it is propitious to have trading done on an electronic platform in an automated and efficient manner.
Listed derivatives trading – In listed derivatives trading there is still an unresolved risk in the system as clients could be crossing their limits while trading through an executing broker
Settlement period – In the U.S. the settlement period for equities is three days after the trade date. This extended period doesn’t have a strong technical or functional rationale.
In an academic article, Christie and
Schultz (1994) observed that during 1991 more than 85% of NASDAQ dealers
quoted even-eighth while odd-eighth quotes were hardly used in 70% of
the stocks. The study was followed by several civil antitrust lawsuits
eventually settled for $1.027 billion because of implicit collusion. The
change to decimalisation happened years later.
Longer settlement cycles of equities give
traders more time to arrange for funds after the trade, resulting in
more trading and leverage. This leverage resulted in more counter party
credit risk and higher overall risk to the system. The plan to reduce
settlement cycles in the U.S. is still under discussion.
While the U.S. has lagged behind in
certain areas, it has also been a trendsetter in many areas, including
regulations. Here are a few examples.
Equities trading – U.S. exchanges and brokers have been ahead with features like Algo and program trading, alternative venues like dark pools, ECNS and best-price rule. This has made U.S. markets competitive with one of the lowest commission fees.
New products – The U.S. was the first to offer new instruments like credit derivatives (started in 1993) for trading; many new order types were also pioneered by US exchanges.
OTC trading/SEFs – The Dodd Frank rule brought significant changes in OTC trading. The U.S. is the first to introduce SEFs (Swap Execution Facility) or trading venues for OTC contracts and the ecosystem around it which includes credit hubs and clearing houses.
Derivatives risk calculation – The U.S. has been leaders in derivatives risk calculation models (VAR calculations were introduced in 1990) and in pricing, greatly enhancing financial markets.
Equities trading – U.S. exchanges and brokers have been ahead with features like Algo and program trading, alternative venues like dark pools, ECNS and best-price rule. This has made U.S. markets competitive with one of the lowest commission fees.
New products – The U.S. was the first to offer new instruments like credit derivatives (started in 1993) for trading; many new order types were also pioneered by US exchanges.
OTC trading/SEFs – The Dodd Frank rule brought significant changes in OTC trading. The U.S. is the first to introduce SEFs (Swap Execution Facility) or trading venues for OTC contracts and the ecosystem around it which includes credit hubs and clearing houses.
Derivatives risk calculation – The U.S. has been leaders in derivatives risk calculation models (VAR calculations were introduced in 1990) and in pricing, greatly enhancing financial markets.
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