The Global Financial Centres Report 2010, produced by the City of London Corporation and Z-Yen, has for the first time set London and New York on a par, as joint world leaders.

Historically, London and New York have been considered financial centres due to their infrastructures. The stock exchanges and the rules of the market that affect their efficiency, have been successful in making London the centre for Europe and New York the centre for America.

However, huge changes have taken place in the last ten years. Neither the London or New York Stock Exchanges have the position of market dominance that they once held, having been cut down to size by upstart competitors.

Likewise, those ten years have seen systemic failure and abuse in the financial markets, leading to ongoing change of the rules by which they are governed.

With the exchanges weakened and rules uncertain, it is hard to pick a leader from the cities of London and New York in 2010.

Technology is also eroding the need for physical financial centres. The need is not removed entirely, but IT makes life easier for people wishing to operate remotely. As Sang Lee, founder of Aite Group notes, "The real effect of technology has been to make the actual landscape more competitive. If you want to trade in New York or London, you don't have to be based in New York or London. It has levelled the playing field."

New Yorkers moving to Kansas will still find themselves regulated by the Securities and Exchanges Commission, however Londoners moving to Switzerland will find themselves with a different regulator and massive tax breaks. Gary DeWaal, group general counsel for agency broker Newedge says, "Electronics is really making us a global world, but the individual countries don't seem to be cognisant of how mobile we are. You can work in Switzerland and still have your trades booked in London". If a broker can jump on a flight to Geneva and save himself a lot of money there is a good chance that he will. Global business is expanding the definition of a financial ‘centre'.

Plugged in

From the standpoint of technology, London and New York are in a two horse race, but New York has been ahead by a nose. The US equities market is still significantly larger than that of Europe, and having been a battleground for longer it sees the cutting edge of innovation. "Looking at it from the 30,000 feet perspective, in the US, latency and gearing towards latency is more developed. The key reason for that is that the US is the most competitive market," explains Shawn Melamed, chief executive of latency evaluator Correlix. "Following the competition between NYSE and Nasdaq over the last decade, and more recently Bats and Direct Edge being thrown into the mix, for equities the US became the forefront of the battle". He observes that exchanges and other trading venues are the key to driving technological efficiency in the equities market. There will be no point sending orders at microsecond speeds to and from the exchange if it takes 20 milliseconds to process the trade in the venue. Only once the venue has upped its game will there be a value in the trading firms investing in new technology.

Brian Gallagher, head of electronic trading at Morgan Stanley, is in no doubt that European infrastructure does not stand up to comparison with the US market. However he says that the exchanges are already reacting to the challenge, with the LSE clearly motivated by experience, "You only have to look back five months ago when the LSE went down for a full day. Everyone talks about the scope of trading that is done in the US versus Europe: well, I don't think there is the capacity on the [European] exchanges to handle that [volume] just yet. Some of the multilateral trading facilities probably could. There's a scale to this business that all the exchanges are working on building out."

Melamed supports this position, noting that Nasdaq OMX discloses the average latency of trades that run through the Nasdaq exchange, "You don't get that level of transparency in Europe. NYSE Euronext core technology development is in the US, BATS has core technology development in the US, Nasdaq OMX has core technology development in the US. Usually technology would be rolled out in the US first and then it would be rolled out in Europe. I understand that the lag is diminishing. Two years ago I would say that Europe was lagging by a year at least, now I would say that's down to about six months."

Gallagher sees lessons for the London Stock Exchange in New York's recent history. "Four to five years ago the New York Stock Exchange and Nasdaq had dominant but slipping market share in the US. In 2006 I think NYSE had 60% market share. If you look at the LSE today it's hit a very similar precarious position. We know how the story unfolded for New York. They couldn't change their technology; they dug their heels in to the belief that people valued the specialist system when people just viewed them as a liquidity centre. It took nine years for their market share to move from 90% to 60%, and then a year and a half to go from 60% to 30%.

"The LSE is at an important inflection point where they need to improve their technology, lower their cost base, and they have plans to address those issues. That applies to Deutsche Bourse and Euronext as well".

Competition in the US had a significant effect on the structure of the market by driving down the cost of trading. That motivated brokers and fund managers to invest in trading systems according to Gallagher, "Frictional costs are lower in the US and that has encouraged different types of market participants to develop. High frequency trading makes up somewhere around 60-70% of the market, whereas in Europe it might be 30-40%. I think the lower costs in the US have partly been responsible," he says.

The European Commission and the European Central Bank have been forcing the firms that constitute the infrastructure to lower their charges through regulation. Competition in the spaces of trading and post-trade processing is being created by the Markets in Financial Instruments Directive, the EC Code of Conduct and Target 2 for Securities. In the pre-trade space this has been successful with numerous trading venues offering low cost services, however post-trade processing costs are still high. If the costs drop and trading volumes increase significantly, Melamed says it will be to London's benefit, "for the reason that the big MTFs are headquartered in London, and Euronext and Deutsche Bourse are losing liquidity to these MTFs, that the trend in the long term for the European equities market is to move to London."

One for all

Regulation of other sorts acts as a barrier to business. The need for systematic stability has meant that the US and European regulators have unified their approaches. Lee says that what occurs on one side of the Atlantic is likely to happen on the other. "There are a lot of ideas being tossed around but things are not set by any means - however I think it's fair to say that what happens in New York is likely to happen in London and vice versa. The regulators are talking to one another."

DeWaal does not believe that there will ever be a level playing field: "You will never get unified global regulation because different countries have different bankruptcy laws."

Giles Nelson, deputy chief technology officer of Progress Apama, adds that London could still look for some advantage from the situation. "I would say, pay close attention to what's happening in the US and let's see where we can competitively differentiate whilst achieving our own objectives. The fact that New York is likely to be first - the openness of the American political system means that we will get to see what is on peoples' minds and perhaps London has an opportunity to take that and say ‘we know how they played their hand, maybe we can play slightly different here'."

But regulators are turning against the firms that have provided the US market with its huge volumes, which,  ironically, threatens the future growth of London.

On May 6 2010 there was a drop in the value of the US stock market, referred to as the flash crash, and instantly people were pointing at technology-led trading to explain the fall. In fact so far the fall has yet to be adequately explained says Lee, but if anything the system itself seems to be at fault, "I spoke to a couple of HFT firms and they said when you look at all of the individuals parts of the market - the broker dealers, the exchanges, the ECNs, the funds - they all functioned as they were designed to function. But added up all together it was disastrous."

Nelson sees a regulatory backlash brewing against electronic trading. "The controversy around high frequency trading has hit the mainstream media where it seems to get blamed for just about everything. So the Central European Securities Regulator will be looking at this, at what happened around the flash crash, will be thinking HFT was a major contributory factor and the risk is we'll see some significant restrictions on this which would be wrong, and an attempt to roll this activity back," he says.

Fragmentation away from the primary markets at the very least exacerbated the situation, says Lee: "We do need better coordination across the market place to avoid such situations. The argument against fragmentation is that it creates these situations where there is no oversight of the market." In Europe the fragmented secondary market was created by MiFID to generate competition between trading venues. From the competitive perspective if one market fails there are still other markets to play on - you eliminate the single point of failure. However in the US, "because the market was fragmented, individual market centres behaved as if they were alone. There is no industry-wide management. I think the events on May 6 2010 were the first incarnation of the argument that market fragmentation has a darker side. There is no layer of common operational standards that everyone abides by," Lee concludes.

Although the cause of the flash crash is undetermined, the US reacted quickly to prevent another by putting in ‘circuit breakers' that halt trading in any S&P 500 company whose stock moves 10% within five minutes. One source believes that was only achievable by virtue of its regulatory structure: "The market structure in the US is built on rules-based regulation. You find a problem or a behaviour you want to change - put a rule on it. There was Reg ATS, and then Reg NMS and more recently the circuit breakers put on the market following the events of May 6. In the UK and Europe you don't have a regulator that comes to you and says do this, this and this, meaning there are no uniform standards."

In turn, that threatens Europe's ability to react to similar situations, making it less structurally secure. If it is not able to cope with HFT business, London will not see the predicted growth and it will not catch up with the New York. "Europe has to make a decision, either accelerate the move toward unification or break apart. The status quo doesn't work. We're seeing too much arbitrage in the regulatory environment," says DeWaal.

Although Nelson notes that "there's no technical reason why CESR as a pan-European organisation could not view all activity on European markets on a real-time basis," there are 27 reasons why Europe may not take a unified approach to regulation and 26 of them don't have London as their capital city.