What is Market Fragmentation And Connectivity?

In the existing global market, the market players have to deal with two opposite forces; market fragmentation and connectivity. Connectivity integrates the market, while fragmentation creates more subunits. Investors located globally seek new sources of ROI and try to connect these sources in a timely and inexpensive manner. This results in more demand for efficient services throughout the trade life cycle in each asset class. Firms seek similar market infrastructure and trade support services across markets. However, the access has to be cost effective, dependable and easily available. Market fragmentation is a well-known concept in developed economies such as the US, its impact is being felt in other markets. Connecting to emerging economies is filled with unknowns. Infrastructure is not well developed, distances are more and financial connectivity is a new concept. It is not possible for firms to manage the networks of connections to all the locations and marketplaces independently. They have to identify a scalable mechanism that enables them to regulate their communication mechanism as required, without significant investment. Extranets enable clients to link to an international network of market players, exchanges and independent service vendors (ISVs) within a customized infrastructure. They exceed geographical barriers, asset class, and trade life cycle. Regulators are seeking greater transparency and competition. Market fragmentation is beginning to unfold across global markets. In the recent past, certain specific markets have fragmented. As markets become automated and more integrated, increased competition and costs would force distinct nations to fragment on a case-by-case basis, resulting in more complication for the existing connectivity model. Therefore, while distinct markets remain disconnected, and the disconnected markets start to fragment, it would become tougher for firms, particularly smaller and mid-sized firms to sustain internal connectivity tactics. Though firms prefer the reliability, security and robust attribute of their internal connectivity networks, they are increasingly getting concerned about the ease and cost of developing the networks. Hence, connectivity has become the main priority. Most firms believe that market fragmentation would challenge their present connectivity strategy. Firms are open to working with an outsourced solution such as extranets. The value received by partnering with third-party vendors is a powerful driver. As investors seek new opportunities, the various entry barriers (infrastructure, regulatory, informational barriers) become greater. The partnership with an efficient vendor could decrease the barriers substantially. The same is applicable for the Swaps market, especially in the US. Due to Dodd-Frank, Swap Execution Facilities (SEFs) are being established across locations; every venue needs connectivity not only to the exchange but also to trade life cycle participants that increase the liquidity in the facility.

The advanced model facilitates a many-to-many relationship, where all functions are within the SEF. It would deliver continuous two-sided quotes and time sensitive trade reporting. At present, market players across the globe are trying to identify a method to efficiently connect where required. Traders would have to overcome two challenges – liquidity and market fragmentation and both revolve around the issue of connectivity. Extranets fulfil a crucial role with regard to the communications infrastructure of the financial services sector. They deliver powerful, scalable communications to firms. Financial-services extranets cater particularly to the financial services players. The costs of an extranet depends on many factors: The quantity and size of the connections. The distance. If analysed from a security perception, extranets deliver a level of security that facilitates improved reliability and negates risks related with unlimited access to key network resources. While looking at scalability, there are three separate features that would have to be considered: The capability of a firm to scale upward or downward. The capability to increase bandwidth and counterparties. The capability to remove indirect costs. Though extranets play a vital role within the financial services connectivity domain, their role does not remove the requirement for other types of connectivity. Firms can leverage various communications technologies to implement their business strategies. Having said that, extranets provide the most cost-effective solutions to firms. If a firm decides to expand to a new market; either through expansion or asset class diversification, connectivity is the key factor. The connectivity movement has reduced the total cost of global trading. Currently, investors have several markets to choose from and extranets have facilitated this process. Due to extranets and their capability to interface several participants together in a secure environment, investors located globally are looking for new products & services to assist in managing the challenges in a transparent manner. Extranets enable market players to expand expeditiously, thereby ensuring they can access key counterparties throughout the trading lifecycle like: Pre-Trade Services. Trade Execution Services. Post Trade Execution Services. Market players look for performance, reliability and security when connecting to new markets. Extranets ensure better performance while decreasing costs. Extranets within the financial-services domain would be relevant in the future. They are accepted by the various players in the financial services sector – the small buy-side firm seeking to connect to its broker, the huge sell-side bank that would like to decrease the operational complexity of its communications infrastructure. However, they would be dynamic in nature and constantly evolve with the markets. They would continue to deliver value to a globalized capital market, which is increasingly witnessing automated trading. Factors such as size, reliability, performance, customer service would differentiate the extranet service providers. In the long run, these factors would decide the success of the service providers.

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