InformationWeek

June 11, 2001

Tricks Of The Trade
With its patchwork of laws, Europe is a perfect testing ground for Nasdaq's goal of creating a global securities market

By Eileen Colkin (ecolkin@cmp.com)

More on Nasdaq:

Nasdaq Threatens To Delist Two More Internet Companies (03/29/01)

InternetWeek: NASDAQ Takes Down SelectNet (06/05/01)

asdaq moved closer to its goal of building and operating a global trading exchange when investors successfully bought and sold the first stocks over its new pan-European network on June 8. The Nasdaq European Trading System marks the first time Nasdaq has created an exchange that permits trading across countries. Next, Nasdaq will try to apply the lessons it learns in Europe to create a seamless, global market that links exchanges in the United States, Canada, Europe, and Japan.

"Nasdaq wants to be a vehicle of consumer trading," says Gregor Bailar, CIO of The Nasdaq Stock Market Inc. in New York. "We want to break down [barriers to trading] in Europe, and the long-term vision is to provide that same capability across the United States, Japanese, and European borders."

Opening day trading volume was low, but all went well. (The same day, the New York Stock Exchange halted trading for more than an hour after a software bug prevented trading on half the floor.)

Europe is a good testing ground for Nasdaq's strategy. The exchange had to develop an application that could conduct stock trades according to the laws of the countries in which the transactions take place, a key foundation for moving forward globally, when even more laws and idiosyncrasies come into play. Tibco Finance Technology Inc., a subsidiary of Reuters that specializes in financial-services applications, spent 18 months building the application.

It was a complex exercise. Each European country has different rules governing how transactions are monitored for unusual patterns, the amount of time allowed for settling a trade, and the management of risks associated with losses because of an error on the part of buyer, seller, or market. "There's a forest of these rules," says Fred Meyer, chief marketing officer for Tibco Software Inc., an E-business vendor that provides the messaging infrastructure used by Tibco Finance. "They're mind-numbing."

There are other hurdles. Nasdaq must resolve issues surrounding the clearing and settlement of cross-country trades, a costly process in which a trade sits in an electronic repository while awaiting regulatory approval via one of Europe's 16 clearing and settlement houses. Those firms typically use proprietary mainframe technology that's not easy to access. Nasdaq connects to them via third-party clearinghouses Clearstream and EuroClear.

But that process costs $50 to $75 per trade, so the exchange wants to bypass those systems altogether. In a partnership with the Depository Trust & Clearing Corp., a New York clearing and settlement group, Nasdaq Europe is developing its own central counterparty--a centralized clearing center that issues promissory notes to buyers on behalf of sellers. Nasdaq expects to cut costs by a factor of 10 for high-volume users, says Lee Gordon, Nasdaq's senior VP of strategic initiatives. The savings will be passed to market participants.

Nasdaq is outsourcing much of the technical functions of its clearinghouse to Depository Trust & Clearing, which will provide the operating systems and support for the clearinghouse once it's launched by year's end.

Another key project for Nasdaq is the creation of SuperMontage, a quote and order-processing system that will give traders insights into stock values beyond the current bid price. SuperMontage will collect and display multiple bid prices simultaneously. The system will be deployed in Japan this year and Europe and the United States next year.

Nasdaq, which handled about 4 million trades per day in the United States during the first quarter, entered the European market in March when it acquired a majority stake in Easdaq, an exchange trading across European borders. Nasdaq transferred Easdaq's historical data to its new network last week. "We were starting with something that was directionally correct, or at least close to what participants were looking for," Bailar says. Easdaq had offered price quotes online, but trades were handled over the phone. To turn the system into an electronic network, Nasdaq assembled a team of developers, consultants, and technology vendors, including Cap Gemini Ernst & Young, Tibco Finance, and Global Crossing, to adjust the applications to meet Nasdaq's response-time and performance standards. "The business functionality is critical," Bailar says.

That's one reason a high-speed network was important. The market demands better than 99.99% network uptime; Global Crossing, which was involved in the development of Easdaq, says it exceeded that benchmark during testing. The carrier hosts the systems that manage the stock transactions: four Sun E4500 database servers and 18 E420R application servers in redundant data centers in London. Forty-five Nasdaq trading firms and remote Nasdaq offices access the centers via 256-Kbps to 2-Mbps leased lines.

As is true for Nasdaq's U.S. network, every line from a broker to Nasdaq is dedicated. Global Crossing uses firewalls and access controls at each router to prevent break-ins. Coding inside the exchange limits who gets in.

Global Crossing uses IP and asynchronous transfer mode switches in its optical network, and traffic is routed using TCP/IP. Nasdaq needs to send stock-price updates in as close to real time as possible, so it can't tolerate high latency. That typically isn't a problem within regions, but with global networks, traffic must pass through more network devices, increasing delays. Global Crossing's optical network transmits data from the United States to Japan at the superfast latency of about 100 to 120 milliseconds.

Actual delays vary depending on access speeds and on the byte sizes each application designates for the data, an important consideration when Nasdaq goes global. To prepare, Global Crossing and Nasdaq fine-tuned the European apps to put data in a packet size that optimizes network performance.

Stock-price updates are delivered using multicast technology, which lets companies send the same information to multiple sites without wasting bandwidth or server capacity. Instead of sending separate streams of data to each network site, a central server sends one stream to a multicast-enabled router, which distributes the data to other sites.

Nasdaq requires redundancy everywhere in its network, but redundant multicast networks aren't common, says Wassil Kacha, network engineer for Global Crossing. The market and Global Crossing spent months adjusting the multicast network to recover quickly in the event of an outage.

Much of the know-how being applied in Europe was accumulated in the past year during Nasdaq's launch of a Japanese exchange, which operates as a section of the Osaka Securities Exchange. Top on the list in the Japan effort was the need to establish operational rules that conform to the regulations of the local economy, specifically governing the signing of initial public offerings. Nasdaq Japan launched just as the economy there began to slow, giving the firm time to adjust its processes. Even as the number of IPOs dwindled, Nasdaq Japan was able to pick up about 30% of those launched during its first year. It now lists 53 companies. That's a far cry from the 4,800 companies listed in the United States, but it's in line with the company's early market-share goals.

Eight financial institutions and market participants, including Credit Suisse First Boston, Goldman Sachs, Lehman Brothers, and Schroder Salomon Smith Barney, last week disclosed investments in Nasdaq Europe. They join the Knight Trading Group, which has invested in the project from the start. Stocks on the new exchange will be traded in the currency of the listing country. Nasdaq expects most transactions in euros, but it supports multiple currencies.

But some observers wonder whether the Nasdaq European Trading System will have long-term viability. "The real question isn't going to be whether it works now," when trading volume is relatively light, says Damon Kovelsky, risk and trading technology analyst at Meridien Research. "The real test will be in September." That's when summer vacations end, and European businesses operate at full speed. "We'll probably start slowly for the first few months as we'll be literally hooking up the co-owners of the market," Nasdaq CEO Hardwick Simmons said at a news conference on June 8.

Nasdaq faces competition from companies such as Deutsche Bourse, virt-x, and Euronext, which are building their own pan-European exchanges. What's more, varying international regulations from agencies such as the Securities and Exchange Commission prohibit most open stock trading between the United States and foreign countries. Nasdaq hasn't yet received clearance to open those trade doors.

Nasdaq hopes to link its exchanges to create a single trading market within about two years. Assuming it gets clearance, "We'll link them in short order," says Lee Congdon, Nasdaq's senior VP of strategic initiatives. By then, he promises, all the technology issues will have been hammered out.

--With Robin Gareiss, Martin J. Garvey, Antone Gonsalves, and Christopher T. Heun

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