Forum:
Electronic Markets and the City

Von Pe Ru Tsen, Center for Metropolitan Studies, TU Berlin
E-Mail: <pe-ru.tsenmetropolitanstudies.de>

Introduction
Modern information technology and globalization have transformed
traditional communication patterns in many fields of science, business
and technology. Electronic media have become an integral part of our
daily environment shifting the focus from face-to-face interaction to
face-to-screen interaction. In this process, the screen and its digital
tools have become new actors challenging traditional communication
patterns and social practices: via the screen, human beings are not
limited to interaction in a physical environment but can also
participate electronically.

One of the fastest changing industries in this development is the
financial industry which has extensively explored the possibilities of
technology. Within the last twenty years, most exchanges have
successfully introduced electronic trading systems automating the
trading process and connecting market participants worldwide. Electronic
order books and market data are globally accessible allowing traders to
operate from remote places and in many markets simultaneously. Price
discovery, transaction, clearing and settlement no longer require a
face-to-face environment but can alternatively take place in an
electronic environment. After centuries tied to centralized trading
floors of exchanges, information technology does not only provide a new
operational system but also a new spatial and temporal experience.

Since the introduction of the first full-electronic exchange in 1971,
electronic trading has become more and more efficient in terms of
capacity, speed and market structure. This development has attracted
many traders to move from floor trading to electronic trading causing a
big struggle for many traditional exchanges like, for example, the
London International Futures and Options Exchange (LIFFE). In early
1997, LIFFE was the largest futures exchange in Europe successfully
operating a trading floor for German Government Bonds but only within a
few months, however, it lost about 80% of its market share to the
Deutsche Terminbörse, now Eurex, which competed with the same product
but introduced an electronic trading system. Today, a number of physical
trading floors still exist, primarily in Chicago and New York, but
electronic trading is increasingly taking over worldwide. The Chicago
Mercantile Exchange, for example, generated 66% of its trading volume
via its electronic platform in the first quarter of 2005 compared with
only 15% in 2000. And in Europe, where electronic trading has generally
been more popular than in the US, electronic trading systems like XETRA
have been even able to generate more than 97% of the total trading
volume. In addition, many exchanges such as Archipelago, for example,
never had a physical trading floor but only operate electronically.

As these numbers show, floor trading is losing more and more volume to
electronic trading; the trend is certainly set raising the question of
how this technological change has transformed the financial market. How
and where do electronic traders operate today? And what are the
implications for cities?

In the following article, I will explore these questions beginning with
a brief introduction about early forms of exchanges and their presence
in cities. This is followed by a number of examples about typical
processes on both physical trading floors and electronic trading rooms.
In the final section, I will conclude with a discussion about chances
and challenges for cities.

Early Exchanges and their Presence in Cities
Financial exchanges are one of the oldest institutions in cities. Early
forms of exchanges presumably date back to transnational trade markets
and trade fairs in the Middle Ages where merchants would gather together
at regular intervals to trade goods and commodities, exchange economic
information, and speculate about future prices, supply and demand.
During these fairs and markets, they would also fix currency exchange
rates, determine interest rates for loans and sell insurances for
prospective goods. These trade and trading activities gradually evolved
into its own institution outside the trade markets and trade fairs
resulting into institutionalized exchanges. In Europe, the Brugge
Exchange and the Antwerp Exchange, founded in 1409 and 1485
respectively, are considered to be the first exchanges operating under
the specific name and function of an exchange. Many major cities
followed their example and also established exchanges in the centuries
thereafter, such as in Lyon (1540), Frankfurt (1585), and Amsterdam
(1608).

Traditionally, exchanges were located at strategic sites such as cities
with shipping ports, major transportation routes or trade fairs and
trade markets. They highly depended on the density of people and
businesses, and consequently, chose prime locations in the city. Similar
to cathedrals and city halls, for example, exchange buildings formed a
key element of the urban fabric functioning not only as an economic and
financial centre but also as a local identity in the city.

Especially during the 19th century, the importance of exchanges in
cities and their prominence in the urban landscape increased. Due to
industrialization, companies were in great demand of raising capital for
new industries, and exchanges were able to address their needs fostering
wealth and prosperity in the city. In order to meet the increase of
trading activities on the floor, many new exchange buildings were built
or existing exchange buildings extended during this particular period.
Simultaneously, the architectural expression of exchange buildings also
transformed becoming more monumental and prominent in the city. They
reflected the new power and self-confidence of the new capitalist middle
class which had emancipated itself from the feudal structures and
prospered during the industrialization. As a result, exchanges became
more prestigious and elaborate gaining equal importance in the city like
major public buildings.

In sum, traditional exchanges and cities enormously profited from each
other's presence in the 19th century. Exchanges relied on the density
and diversity of the city, while cities gained prestigious and wealthy
institutions with the existence of exchanges. How did this mutual
benefit shift with the rise of information technology and globalization?
A closer look at the communication structure and the spatial
configuration of both floor trading and electronic trading shall provide
a first approach for this question.

Floor Trading
At physical exchanges, trading is regulated by exact trading hours and
limited within the perimeters of the trading floor concentrating all
market participants physically and temporally. Traders assemble
face-to-face on the trading floor shouting and hand-signaling their bids
and offers to each other. Prices and order sizes are the key information
for floor traders but in addition to these abstract numbers, they also
look for 'ambient' information from visual and acoustic cues such as
noise level, crowds and movements on the floor to evaluate the overall
market situation. Empirical studies on noise level, for example, have
shown that increases in noise level correlate with higher volatility
providing important trading signals.

In addition, traders can quickly identify who is placing an order. At
some exchanges, traders also wear differently coloured jackets with
company names printed on it which make it easy to track the order back
to the company, even when traders do not know each other personally.
Knowing where orders come from is important information which can help
to anticipate potential price movements. If a large firm like Goldman
Sachs, for example, places an order, it is very likely that the order
will be relatively large, and, therefore, have great impact on the
market price. Traders, therefore, are on the alert and can adjust their
positions accordingly. Orders which are placed in the electronic market,
however, are anonymous and give no indications which firm is behind the
order.

Because products are strongly interconnected and often follow trends,
traders also pay attention of how related products are performing. On
the floor, trading pits of these products are often in close proximity
to each other, and, therefore, easy to watch and overhear. Traders in
one pit, therefore, can see and hear what is happening in other pits.
This type of information is very valuable for traders to adjust their
risk positions.

Furthermore, floor trading generates a group dynamic where a limited
number of 'leaders' will drive the actual market price. These key
players basically set the benchmark, and the rest of the traders can
place their bids and offers within a spectrum of this benchmark.
Traders, therefore, closely observe these leaders and use their
movements as indicators for the overall market situation.

To sum it up, on the trading floor, knowledge is not only represented in
explicit forms such as prices, orders and market data but is also
embedded in the physical presence and practices of the market
participants. These visual and acoustical cues provide an important
context to assess the market, and implicitly signal opportunities and
warnings to traders in a market of great uncertainty. Because floor
trading bounds traders to a physical place traditional exchanges define
with their location where traders operate, and, therefore, keep market
participants close to the city centre.

Electronic Trading
Today, however, electronic exchanges allow traders to participate in
market activities in real time without the need to be physically present
at the same place. Traders have direct access to market data and trading
platforms worldwide communicating via face-to-screen interaction. These
transformations have made the financial market more efficient in terms
of speed and capacity but at the same time, they have simultaneously
caused new challenges for traders.

As trading technology and financial products become more complex,
trading does not only demand economic and financial understanding but
also relies on technical knowledge and skills combined with efficient
hardware and software solutions. Some traders compare the transformation
from floor trading to electronic trading with a change from driving a
regular car to driving a racing car. Someone who is experienced to drive
a regular car is not necessarily able to drive the Formula 1 with a
racing car. Technology, speed and course are much more complex and
time-sensitive making a change from one to the other extremely
difficult.

Similar to Formula 1 drivers, traders are central but not the only
actors in electronic trading highly depending on specialists. Traders
and engineers need to collaborate with each other constantly exchanging
ideas and knowledge. Especially proprietary trading systems are very
sensitive, and, therefore, require much higher maintenance than
off-the-shelf solutions. Hence, traders often work closely together with
IT developers and financial engineers in a face-to-face setting.

The second challenge for electronic traders results from the exponential
growth of digital information. Easier market access, lower transaction
costs and better technology have generated an abundance of market data
making it necessary to filter relevant information electronically. The
development of automated trading signals, therefore, has become standard
in many fields, demanding a close collaboration between traders,
analysts and engineers. Especially in algorithmic trading, where speed
and complexity are extremely critical, constant feedback between those
who develop the system and those who operate it is very important. In
order to communicate and fix complex problems without time delay,
traders, analysts and engineers often sit in close physical proximity to
each other.

Another challenge for electronic trading is the type of information
available on the screen. Unlike on the trading floor where noise level,
body language and crowd movements provide ambient information,
electronic trading systems only generate information in abstract
numbers. Technology can efficiently transfer digital market data but it
cannot replicate the complex knowledge communication of the trading
floor. Traders, therefore, have to learn to interpret the market without
the social interaction of other market participants.

Instead, they focus on close collaboration within their own company. For
assessing the market, they develop new trading strategies as a team,
contextualize news and numbers, and constantly share comments and alerts
with each other. In this process, the trading room transforms into a new
type of knowledge space where traders and their teams use both
electronic and physical communication sources. They monitor the market
via the screen, and simultaneously assess their individual observations
face-to-face with their co-workers. For this, they collaborate both
organizationally and spatially.

Trading rooms are typically organized in open plan offices where trading
desks are arranged with maximum density allowing them to see and hear as
many co-workers as possible. Seating positions and configurations are
often carefully orchestrated fostering close collaboration within teams,
and additionally, between teams with interdependent products. In
general, good sightlines and acoustics are considered to be one of the
most important features of trading room design.

For the filtering and interpretation process of market data, trading
rooms seek for people from different disciplines and experiences. These
highly skilled people need to make their own decisions independently but
integrate themselves easily into teams at the same time. Communication
has to be fast and transparent leading to flat hierarchies and
organizational diversity.

To summarize, electronic trading can technically be operated from any
location worldwide but this does not mean that traders can work isolated
without any personal interaction. The increase in information technology
has created complex trading mechanisms which require close collaboration
between traders and many specialists. For cities, this implies both
chances and challenges.

Chances and Challenges for Cities
Most researchers agree today that information technology has made
financial markets not less but rather more concentrated in the urban
environment. The development of cities such as New York, London and
Tokyo suggests that technology itself may have made processes more
flexible but at the same time, also more dependent on human capital and
specialized services. The access to highly skilled people and innovative
businesses requires the creative environment of the city where
universities, major financial institutions but also competitors are
concentrated. Many talented people are attracted by the diversity of the
city, and, therefore, trading firms need to be located close by to reach
these high potentials.

Cities have the advantage of extensive transportation infrastructure
connecting many people conveniently. These are not only significant for
those who commute daily but also for those who are globally engaged and
require regular face-to-face meetings in different locations worldwide.
Airports, train stations and local transportation hubs are strategic
sites, especially for trading rooms which need to physically concentrate
a large group of people and hardly engage in telework.

In addition, firms which trade for clients such as brokerage houses and
investment banks need to be in close proximity to the city. Business
relationships cannot be fostered by electronic communication only but
must highly invest in personal interaction and commitment. Social events
such as lunches, parties and conferences, for example, provide important
opportunities to exchange market information informally and intensify
business networks. Beyond pure orders and abstract numbers, brokers and
clients interact personally with each other, and the city centre with
its variety of social places such as restaurants, clubs and public
venues is a strategic location for informal communication. Therefore,
many trading firms which provide services for clients will continue to
depend on prime locations in the city centre because of its dense social
infrastructure.

And finally, the trend of quantitative finance and algorithmic trading
in particular has made trading extremely time-critical. Unlike on the
physical trading floor where social networks dominate the trading
activities and can distort fair competition, electronic trading operates
solely on the principle "first come, first serve". Traders, therefore,
rigorously compete for their own orders to reach the exchange servers
first for fastest execution. Efficient hardware and software can support
the speed but the actual physical distance to the telecommunication hub
of the exchange still plays a major role for some trading strategies.
Due to modern technology, orders can be executed in milliseconds but the
prevailing matching mechanisms technically provide a slight advantage to
firms which are located closer to the host of the exchange. Their orders
need to travel a shorter distance from the company server to the
exchange host, and, therefore, their orders will arrive there
milliseconds before those of their competitors. This may be only a
minimal time delay but for those firms, which have time-critical trading
strategies and automate trading signals and order execution, this
difference matters enormously, and, therefore, the location of the
servers is very important. Locations close to exchanges, therefore, are
not only chosen for business relationships but also for technical
reasons. For many trading firms which engage in time-critical trading
strategies, the city center and its close proximity to the exchange is
still the preferred location for trading effectively. Against this
background, some exchanges are even currently considering to offer
spaces inside the exchange building for locating servers of their
members.

All these above cases, however, reflect only part of the truth. For
cities, electronic trading means also a challenge, and a number of
trading firms will not necessarily need the density of the city centre.

In some organizations, real estate factors will simply drive the
decision for or against cities. As mentioned before, sightlines and
acoustics are of great importance for better communication in trading
rooms and firms require large, preferably column-free, open plan offices
where they can fit as many traders and engineers as possible on one
floor. Often these large office spaces are not available in the dense
city centre, and, therefore, they decide to move into the suburbs where
more opportunities exist to build custom-designed trading rooms which
exactly fit their needs. Trading rooms such as UBS in Stamford
(Connecticut), for example, fit about 2.000 trading positions onto one
floor (equals about two soccer fields) which can simply not be realized
in the density of New York City. For these firms, physical concentration
is extremely important - but less within the macrostructure of the city
but more within the microstructure in the firm.

Also, firms which focus less on time-critical trading strategies may
choose to locate outside the city. For them, being closer to the
telecommunication hubs of exchanges is not critical, and, therefore,
there is no necessity to be located in the city where rents are higher
and commuting more time-intensive. For them, locations in the suburbs
with a good transportation connection for occasional visits into the
city provide a good alternative. Especially those firms which do not
trade for clients but with their own capital and additionally have
access to in-house specialists can be more independent from locations in
the city.

Often privacy factors are also reasons why firms prefer the remoteness
of the suburbs, as with many Hedge Funds. The density of the city means
better access and better communication sources but this may also include
those to and from competitors. Certain trading firms may not prefer this
degree of transparency and consequently move outside the city centre to
protect their privacy.

To conclude, information technology and globalization have significantly
changed trading processes in the financial industry. This has produced a
number of new actors in the field and a variety of new possibilities of
trading strategies. Are cities still important places for electronic
markets? Yes. They continue to be important strategic sites in the
global financial market centralizing technology, infrastructure and
human capital. As we have seen, many firms still highly depend on this
density and diversity, and, therefore, concentrate their trading rooms
in the city. Although the traditional marketplace has vanished, it has
not resulted in the end of urbanization but has rather redefined key
parameters of the city such as physical distance, social infrastructure
and creative collaboration. However, we must differentiate more clearly
between different types of trading firms, their trading concepts and
related organizational and spatial needs to better understand the
complex fabric of electronic markets. We will find that in addition to
the large number of firms which are directly located in the city centre,
there are also several firms which do not need prime locations in the
city. This, however, does not mean that they do not need cities at all.
Cities will continue to be central to electronic markets, and the
microstructure of trading rooms will drive the decision for the specific
location.

Pe-Ru Tsen is a Ph.D.student in Architecture at Dresden University of
Technology and a Fellow at the Transatlantic Graduate Research Program
Berlin – New York and the Center for Metropolitan Studies in Berlin. She
is interested in the effects of information technology and globalization
on knowledge-intensive industries, and focuses on the financial industry
as example. E-Mail: pe-ru.tsenmetropolitanstudies.de

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