The need for middlemen in modern market structure has been much discussed since the publication of ‘Flash Boys’. The idea prevailing is that in today’s technological age middlemen are no longer needed to help market participants find each other, and are simply making easy profit at the expense of the little guy.
While it is true to say that technology, particularly the internet and digital communication, has radically reshaped the way we all do business (not just in the financial markets), it would be wrong to say that middlemen are no longer needed. Certainly there are fewer middlemen, supply chains have been simplified, and the number of links between the two ends of a purchasing chain have shrunk, to the great benefit of all those concerned at the ends of the chain; yet very rarely can we do away with the middleman completely.
Take publishing: we can now buy a book online, at any time of day or night, and even download it immediately to an electronic device. This is often cheaper and definitely more convenient for the customer, and offers a far wider choice than a physical bookstore can ever hope to do. But while this efficiency is great for the customer, the bookshops, especially small local ones, are barely breaking even: their role as middlemen in this transaction is being squeezed. This situation would never have occurred without the change in technology, making it possible to sell books via a new and cheaper middleman in a way that benefited the end consumer.
Similarly, whereas once we had to go to a travel agent to be able to book a holiday, now we can simply go online, looking for the best possible deals for our flights, hotel, car hire etc. There are far more competitors for this business, with individual and aggregated / comparison sites (middlemen), as well as the ability to book directly from the airline or hotel (no middlemen at all), cutting out the need to pay travel agent’s fees. The travel agent still exists, but more and more of their business is to provide a combined version of these services online, or to provide a custom-made holiday plan for a more comprehensive package.
The internet has reduced the cost of many day-to-day consumer purchases, by replacing middlemen with cheaper alternatives (often due to greater competition) and in some cases removed them completely, bringing customers into contact with the manufacturer. And while this has changed the way we do business, accepting the new technology as part of our everyday lives brings a lot of benefits and keeps us primed for future innovation.
Similarly, the rise of algorithmic trading has cut out a lot of middlemen in the markets: the jobbers and specialists, who were once integral to the trading process on the exchange floor, are now obsolete. In Europe exchanges are signing up electronic market makers (liquidity providers) to guarantee continuous liquidity in both liquid and illiquid stocks.
Until recently the markets looked like this:
Everyone had to go through a banker or a broker to trade on the markets; they acted on our behalf communicating with the exchange. But even once it got to the exchange a different floor broker would have to trade with a jobber or specialist (types of market maker) to get the trade executed. At each of these levels a commission would be charged for carrying out the transaction – costs that soon added up, especially with fixed fees.
At their simplest the markets now look like this:
Many of the old high-cost middlemen have been removed from the system through advances in technology, enabling more participants to connect directly to the exchange, and the rise of electronic market-makers providing liquidity. Those who remain have had to find new, more cost-effective ways to provide their service, due to increased competition – for example electronic broker platforms, where private investors can view market data at home and trade it themselves in real time.
The internet and corresponding developments in network capabilities have created a huge hub of information, and the ability to transport data at very high speeds throughout the world. We can now read breaking news from the other side of the world, as well as hearing it from your local news broadcaster.
Like everywhere else in the economy, replacing the middlemen through technological advances has naturally reduced costs for end users. Meanwhile the markets are still kept liquid by electronic liquidity providers – so we can take it for granted that the other side of our trade will always be taken, and we can get the price we want on the exchange we use every day. These changes, made possible by ever developing technology, are net positives to the markets and society more broadly. Embracing these changes, rather than bemoaning things aren’t like they used to be, helps the markets be adaptable, resilient, and flexible – all extremely important characteristics for the free and healthy flow of capital.
The views expressed in this blog post are the personal opinions of the author and do not necessarily reflect the official policies or positions of the FIA European Principal Traders Association or the Futures Industry Association.
