Financial Update (October-December 2000)
Atlanta Fed Conference Explores E-finance and Its Effect on Markets
he explosion of technology, the ability to closely control investments, the promise of low transaction fees, and the ease of buying and selling securities over the Internet have changed the way many investors approach financial markets.
Technological advances have also altered the way professional traders do business and may ultimately change the way regulators supervise market participants. These and other issues on the topic of e-finance, which involves a global marketplace driven by more automated and efficient forms of technology, were explored at the Federal Reserve Bank of Atlanta’s 2000 Financial Markets Conference.
Conference participants, ranging from researchers and bankers to policymakers, brokers and traders, discussed potential changes in the structure of the U.S. equity markets, regulatory questions, clearing and settlement issues in financial transactions, and liquidity challenges in the Internet age. These topics are of keen interest to the Federal Reserve since the passage of the Gramm-Leach-Bliley Act in 1999 made the Fed the umbrella regulator of financial holding companies, which give banking organizations the opportunity to enter the securities business.
Examining regulatory questions
To keynote the conference, Federal Reserve Chairman Alan Greenspan shared his views on the approach financial regulators should take in sorting through the electronic finance issue. He said that regulators should be cautious about efforts to direct the evolution of the financial market infrastructure — including trading systems and payment, clearance and settlement systems. To emphasize his point, he noted that government authorities are poorly suited for picking winners and losers among competing technologies and market structures.
While regulators should not get in the way of markets, Greenspan continued, they also should not remain inactive in the face of the technological revolution that e-finance constitutes. “Supervisors and regulators need to re-evaluate whether these [technological] changes have undermined the effectiveness of their existing approaches and make appropriate adjustments.” As an example, he discussed how the bank examination regime has changed in recent years because of advancing technologies and how bank regulators now depend increasingly on private market discipline, which has always been the most effective form of regulation.
In four policy sessions, conference participants also considered other issues that have been pushed to the forefront by changes in market structure brought on by advancing technologies and globalization.
As markets have become more global and more computerized, they have also become more fragmented. This development, discussed in one conference session, runs counter to the 1975 amendments to the Securities and Exchange Commission Act mandating a national market system. On the surface, a national market system abhors fragmentation and assumes that one market will best serve the needs of all investors, but this assumption does not capture the realities of modern markets, where investors have different needs.
Some conference participants argued that in the global marketplace, the Securities and Exchange Commission will have to give up its goal of a national market system and focus on other issues. Part of the discussion on this topic also focused on how technology will allow a market center or order-gathering function to be located anywhere in the world. As a result, the threat of relocation will place constraints on U.S. regulators, and global trading will make it more difficult for U.S. authorities to regulate investment practices and protect U.S. investors.
Payment and settlement issues
In addition to influencing market structures, globalization and technology are affecting the payment and settlement of transactions in financial markets. This topic was at the center of another policy session in which participants debated the reengineering and continuous-improvement approaches that have proved valuable throughout the economy and that particularly have made it easier to adopt new technologies.
Conference participants discussed challenges and issues financial markets face in responding to three major challenges and opportunities: the invention of financial derivatives and the establishment of exchanges to trade many of them; the availability of computing and telecommunications technologies that can simultaneously link a large, geographically dispersed group of trades and the consequent feasibility of conducting trading by means other than open outcry on a trading floor; and the explosive growth of transaction volume on a number of exchanges.
Technological progress and regulatory arbitrage were discussed as part of a session devoted to price discovery. While these technological developments have enabled newer, more efficient organizational forms of stock trading, the proliferation of trading venues has raised concerns.
Markets have fragmented as new entrants have unbundled the standard package of services offered by traditional exchanges and are competing for only the most profitable portions of the business. Some conference participants asserted that this development poses challenges for federal regulators focused on fostering competition and encouraging innovation and alters the competitive positions of brokers who are customers of the exchanges. Such a landscape, some participants argued, may challenge simple economic maxims such as “the law of one price” and have far-reaching policy implications. But other participants argued that fragmentation is just another word for competition.
Liquidity in the Internet era
In exploring the effect of the Internet on market microstructure, especially in terms of liquidity, attendees discussed how price movements could be viewed as arising from two fundamental forces: new information flows that induce shifts in the consensus beliefs of traders and frictions arising from the trading process. Some participants pointed out that these forces, along with episodes of outright market manipulation, have sharply raised intraday price volatility and diminished liquidity. Others argued that information and automation also allow cross-border linkages that let traders access and link pools of liquidity in very disparate forms.
The future of e-finance
While more questions remain about how markets will evolve and how technological and globalization issues will be resolved, the conference provided a valuable forum for regulators and market participants to assess the opportunities and challenges posed by e-finance.
For more information on the conference, including the papers presented at the policy sessions, click here.