The clubbiness of the City meets high-tech. Decorous hurly-burly on London Stock Exchange yielding to computers
IT was once a bastion of conservatism, a gentleman's club where everyone wore top hats and membership depended on the right connections in the British establishment. It was a place where business had always been transacted by word of mouth, where unwritten rules of conduct prevailed, and discretion bordering on secrecy was the norm. But now, the London Stock Exchange is on the brink of a dramatic revolution that will bring this venerable, tradition-bound institution into the age of modern technology -- and help London reassert its position as one of the world's main financial centers.
To meet the challenges posed by increasingly powerful American and Japanese financial institutions and the growing use of sophisticated computers in international markets, the stock exchange is gearing up to go high-tech.
A new, automated, screen-based electronic dealing system is to be introduced by the end of next year. The system will eventually eliminate the need to trade on the floor of the exchange and accelerate the pace of doing brokerage business.
``We won't have the stock exchange floor; we've lost our top hats; we've lost everything,'' says Brian Winterflood, managing director of Bisgood Bishop & Co., a jobbing (marketmaking) firm. ``It's all been very nice, very cushy, with long lunches. It has been a marvelous way of life for everyone. But in the new world you daren't not look at the screen.'' Enter the computer age
The new system is designed to enable the stock exchange to overhaul its dealing and membership structure. In 1983, the government threatened to sue the exchange unless it changed its restrictive and monopolistic practices. The exchange said it would comply.
The exchange agreed to abandon fixed commissions and open its membership. With the proposed removal of minimum commissions in 1986, the exchange decided to merge the functions of stockbroking with stock jobbing. To handle the new combined broker-dealer structure, a new dealing mechanism had to be devised.
The process of developing that mechanism has not been an easy one, however -- and the exchange is now facing a challenge from Reuters. The British information service has announced plans to establish its own electronic stock market trading service in July, which could eventually compete with the new system being considered by the exchange.
Reuters will use the system created by the New York-based Institutional Network Corporation (Instanet), which has already developed an automatic dealing system in the United States. In the initial Reuters service, Instanet will provide information on US equities and American depositary receipts (ADRs), dollar-denominated certificates issued by banks to facilitate trading in foreign stocks. Although stock exchange rules prohibit members from dealing in British stocks outside the exchange, Instanet will enable them to deal in ADRs of British companies.
There is some pressure within the stock exchange to take advantage of the system as part of the exchange's overall automation. Talks between officials from the exchange, Reuters, and Instanet are under way in an effort to reach an agreement.
Whatever the outcome, the Reuters challenge only underscores the importance of moving into the computer era for the 184-year-old exchange. London's time-zone edge
In the age of high technology, competing marketmakers ``can't operate satisfactorily on the trading floor -- they need to communicate with their clients,'' notes George Hayter, divisional director of information services at the stock exchange and the architect of the new system. ``To compete effectively, there was no alternative but to have computers.''
David Bailey, an equity sales partner at the Phillips & Drew brokerage, adds, ``The system needed to be updated, and computers were the only way forward to become more visible. Without computers the process would be very painful.''
In addition to making the market more ``visible,'' having a screen-based system will enable broker-dealers to take greater advantage of London's place in the world's time zones. But not being tied to a trading floor, Mr. Hayter says, an early broker-dealer will be able to operate in the closing stages of the Far Eastern markets and still catch New York in the late afternoon, giving London the potential to be a 24-hour international financial center.
To put its systems into practice, the exchange is using as its model the 15-year-old National Association of Securities Dealers' Automated Quotation System (NASDAQ), the over-the-counter market in the US. Hundreds of dealers are linked electronically in one system that supplies instantaneous wholesale price quotations from dealers who make markets in OTC stocks.
NASDAQ was chosen as the model because ``jobbing is exactly like NASDAQ on one trading floor, and there was a minimum change of culture,'' Hayter says. ``Competing marketmakers provide a tighter, more competitive system than the specialist [on the New York Stock Exchange]. The specialist ties you to a trading floor. We want to be free of the trading floor, because the world is going to be an electronic marketplace.'' Freer market information
The system to be installed will be a radical departure from current practices and will provide investors with far more information about ongoing transactions than is now available.
Under current practices, bid and offer prices and final sales information is passed by word of mouth among jobbers and brokers. Middle prices between the bid and offer are published in the next day's newspapers and on the exchange's existing network of terminals.
In the new system, about 3,500 British securities will be used for trading on the terminals, in addition to a wide range of international securities. These will be grouped in three tiers according to the frequency and value of transactions.
To protect investors, the exchange will require that the price, size, and time of any given transaction involving the 200 to 300 most active stocks be reported within five minutes of being concluded. For the less active stocks for which there are few marketmakers, dealers must report their last trade to the exchange for surveillance purposes, but the information will not be available to the public until the next day.
The system will also handle trading in the secondary market in government securities, known as gilt-edged stocks, although for last-trade reporting purposes they will be treated similarly to less active stocks. A farewell to clubbiness
The changeover to this new trading system has proved a highly complex and technical process, and to ease the transition it is being carried out in two phases.
First, the exchange will install equipment based on existing systems to meet its 1986 deadline. In early 1987, a more elaborate automatic system with more clearly defined market and user requirements will be installed.
The first phase of the new dealing system will be called SEAQ (Stock Exchange Automated Quotes) and is based on computers designed by Digital Equipment Corporation in the US.
The system will enable marketmakers to enter bid and offer prices and trade reports for most securities in an electronic network of video terminals in their offices or on the trading floor. The network will be linked with Epic, the exchange's current overall midprice reporting system, and with Topic, which competes with outside information services like Reuters, Datastream, and Quotron.
In this initial stage, dealers will not be able to initiate transactions on the terminals, and actual trading will still have to be done on the telephone.
Electronic dealing, however, will occur in the second phase, called MANTIS (Market and Trading Information System). With MANTIS, the telephone can be bypassed and orders automatically executed on the terminal, where marketmakers will also be able to receive comparative quotes, enter orders, and report trades.
When SEAQ is installed, it will be able to handle 20 quote changes or trade reports a second. After MANTIS is in place, it will operate at a much faster pace. With dealing actually occurring on the terminal, it will be able to handle 150 transactions a second.
But the precise form of this second phase remains unclear at the moment. Its estimated cost of 30 million ($55 million) has led to pressure from some members for the exchange to reach an agreement with Instanet and Reuters to incorporate their system into the overall automation of the exchange. Whatever result emerges from the current discussions, a restructured stock exchange with a faster dealing pace, and the ability to trade virtually around the clock, is likely to have a sweeping impact on the importance of London as a financial center.
``London could become a part of the world scene,'' says Phillips & Drew's Mr. Bailey. This reform ``should have been done 10 years ago. Now's the chance to catch up.''
But for an institution that has retained its English way of doing things, the changes are likely to be traumatic. Insiders believe the clubby atmosphere of the stock exchange floor will be destroyed. But ``whoever survives,'' says Bailey, ``is going to make money.''