Preface to the Focus Theme Section: 'Financial Market Engineering'

Tremendous changes are occurring in financial markets and trading organizations as a result of technology developments. These advances in IT have created significant opportunities for economies of scale, reduced transaction costs, and enhanced trading liquidity. New market systems also create major risks for exchanges and their operators stemming as a result of competitive forces unleashed by open, global markets and real-time access. For instance, in the foreign exchange market, sophisticated traders found technological loopholes to exploit the available pricing systems in the market. Deutsche Bank, one of the largest participants in FX, found that it had to turn away 10% of its overall flows in 2005 after discovering such ‘system arbitrage’ taking place through its market systems. Other market technologies have simply fail the adoption test, and do not attract sufficient order flows to remain in operations. Optimark in the US and Jiway in Europe were major market systems launched in the late 1990s that failed. Poorly designed trading venues create the risk of losses, of erosion of liquidity, and reduction in customers and ‘market share’. Traditionally, trial-and-error has been the preferred, although hazardous, approach for designing trading venues. This special issue addresses the need for a more conscious design process. Financial Market Engineering is an engineering approach to market structure that is needed to help market operators exploit the opportunities for ITenabled markets while minimizing the risk of failure. As this focus theme section will explore, successful design of a trading venue requires that the trading rules (i.e., the ‘microstructure’), the technical infrastructure, and the market’s governance form come together to form a solution that leads to adoption and growth in volumes. Engineering questions to address for each of these three areas are: