Xontro to Xetra

The Frankfurt Stock Exchange has paved the way for a speedy migration from traditional floor trading towards a fully electronic platform for buying and selling shares and bonds.

Frankfurt's Xontro floor-based trading system will be replaced by Xetra – a computer-based platform developed by the exchange's operator, Deutsche Boerse - by May 23, 2011.

Electronic trading is increasingly dominating financial markets, bolstered by the proliferation of computerized trading systems, which use mathematical algorithms to power dealing strategies independent of the human hand.

Rainer Riess, a member of the management board of the Frankfurt Stock Exchange and managing director of Xetra market development at Deutsche Boerse, said the migration to the Xetra electronic platform would make the market more efficient and reduce financial risks.

Market demands electronic trading

Des Peck, head of marketing at Atrium Network, a low latency connectivity provider in London, said the move by the Frankfurt Stock Exchange was an "interesting counterpoint" to recent comments made by Finance Minister of France Christine Lagarde, who called for more regulation of high frequency trading, which is powered by computers.

"The Frankfurt Stock Exchange was one of the last bastions in floor-based trading in cash equities," Peck told Deutsche Welle.

"What we are seeing is an exchange responding to client demand for electronic market places yet at the same time we still have politicians calling for stringent regulation of high-frequency trading."

Germany led the way

The rapid growth of electronic trading in global financial markets began in Germany in January 1990, when Deutsche Terminboerse (DTB), the Frankfurt-based derivatives exchange now rebranded as Eurex, first introduced its electronic trading system.

The DTB’s adoption of a screen-based, electronic trading platform enabled it to wrestle complete control of the lucrative Bund contract for German government bonds from its arch-rival, the London International Financial Futures and Options Exchange (Liffe), by April 1998.

Artur Fischer, joint-CEO at Boerse Berlin Equiduct Trading, was an intimate observer of the early adoption of electronic trading and the DTB’s fierce struggle with Liffe.

"When the Bund contract moved from Liffe to the DTB it was an historic event which changed the world of derivatives trading at that point in time completely," Fischer said.

"It shows that if Deutsche Boerse intends to do something it is quite capable of actually achieving it."

'Flash crash'

In May this year, a highly publicized "flash crash" resulted in the Dow Jones Industrial average plunging nearly 1,000 points in 20 minutes. The Securities and Exchange Commission (SEC), a US financial regulator, has since piloted "circuit breakers", which halt trading if prices move 10 percent or more within a rolling five-minute period.

Fischer of Boerse Berlin Equiduct Trading said the pan-European trading platform has "market breakers" in place, which check if traded market prices can be justified by market conditions.

"If we had a situation like the flash crash, we would have intervened and stopped those trades because they were not reflecting market conditions," he said.

Bob Giffords, an independent banking and technology analyst based in the UK, said the 'flash crash' on the Dow showed that most algorithms were still not sufficiently developed to take a balanced view in "highly disruptive" market conditions.

"They are calibrated for normal conditions but not for the extreme volatility of market crashes, which are pretty impossible to simulate anyway," said Giffords.

"A human being can react to the full richness of what is happening whereas algorithms tend to be quite limited at what they look at, and so in chaotic moments may fall apart or rush into crowded trades. In such circumstances a sensible trader should switch them off."

Regional exchanges 'polarized'

A senior official at a major regional exchange in Germany said Deutsche Boerse’s decision to switch all trading to the Xetra electronic platform would "polarize" the business of trading in Germany by increasing trading costs at regional exchanges throughout the country.

"Currently the cost-base is shared by all seven [regional] exchanges including Deutsche Boerse, which carries the majority of the costs. By moving out of Xontro and just using Xetra, Deutsche Boerse will have cost savings but the regional exchanges will have more costs to pay. This will force the exchanges to move much closer together to overcome the cost disadvantage," the official, who did not wish to be named, told Deutsche Welle.

Germany has regional exchanges in Bremen, Berlin, Dusseldorf, Munich and Stuttgart. The Hamburg and Hanover stock exchanges merged in 1999 to form BÖAG Boersen AG.

Riess from the Frankfurt Stock Exchange, said: "Given the size of Deutsche Boerse we have served a higher cost burden in that operation in the past and by decreasing our participation in this venture obviously others will have to pay more according to their usage."

Legal change

The senior regional exchange official added that the migration from Xontro to Xetra would also change the legal framework under which market makers at the Frankfurt exchange operate from public law to civil law.

"In the past market makers have been successful in lawsuits against Deutsche Boerse when the exchange attempted to take away instruments from market makers," the senior exchange official explained.

"By moving everything into civil law [with the migration to Xetra], Deutsche Boerse can now create a contract and market makers will have to either take it or leave it."

Riess of the Frankfurt Stock Exchange said: "This allows us to reward specialists for performance and in the interests of investors, rather than to self-service a job profile that may not be up-to-date any more."

Author: Joe Morgan
Editor: Sam Edmonds