It is 11 AM in New York. Chicago, IL-based trader, Vaibhav Dutta has just placed an order to buy 20 shares of the retail giant, Walmart, through his online broker. In less than a second, he gets a confirmation that the order had been executed and the shares were bought for $52.32 a piece.

The good news is the transaction fee that Dutta incurs is a few cents lower than what it used to be earlier. The reduction in transaction cost is because Dutta’s online broker internally matched the order and did not send it to exchange floor, thereby saving exchange charges.

At trading firms where 100,000 transactions take place, suppose it cost 2-3 cents per transaction, then the total transaction cost would be around $2000. By using internalization tools, if one is able to match 5 or 10 percent orders internally, that would be a significant saving on explicit costs.

Internal marketplace is like a miniature market that is internal to the brokerage firm. The tools developed for internalization consolidates the data and matches the order. If a small percentage of orders are crossed, those transactions need not be sent to the exchange.

By internalizing orders, brokers and large institutions can lower the transaction costs and pass on the benefit to individual traders.

Top brokerage houses like the Citigroup, Morgan Stanley, CSFB have recognized the value of leveraging their internal liquidity with the external markets and have already developed their own sophisticated algorithmic trading engines.

With the Securities and Exchange Commission considering market structure changes to ensure that investors get the best price in stock trades, there is growing pressure on institutions to lower their trading costs and minimize market impact is causing market participants to consider internalization and crossing systems. Even the rest of the tier-1 and tier-2 brokerage firms are now trying to catch up with the early adopters.

Sensing the impact that internal marketplace would offer, Bangalore-based Elind Computers sought to cash in on the emerging opportunity. Elind’s software programmers are developing technology to internalize order flows.

Added to this the consolidation of the securities industry is opening up new opportunity. Over the last few years several institutional dealers have acquired retail brokerage houses, because of which there is fragmentation in order flow. In fact, many firms that are entrenched with disparate legacy technologies must adapt or be left behind. Greg Johnston, CEO of Elind sees a significant opportunity in bringing together orders from disparate order management systems.

Elind’s internalization engine, Stride, aggregates internal market data and positions with external market data. In addition, the engine can intelligently cross and/or route orders depending on the liquidity source. In the U.S alone there are 13000 firms that include the institutions on the buy side, brokers on the sell side and the exchanges. “Our addressable market is roughly about 3500 firms and this is approximately a $5 billion market,” says Johnston.

Research by the Plexus Group states that the retail investor is paying implicit costs on the transactions because of various inefficiencies in the market structure. Present day market inefficiencies cost the industry $100 billion in implicit costs every year.

“By deploying a order flow management tool, brokerage firms can extract value out of the order flows across various internal and external sources. By this, firms can create internal efficiencies, and provide improved service and lower trading costs,” says Johnston, noting that Elind is in talks with several brokers. The company is also adopting Managed Service Provision (MSP) model to deliver internalization services to the industry.

Early Days
Building an internalization engine out of India for the North American market isn’t easy. The founders of Elind have learnt the hard way, redefined the company’s strategy many a times, survived the disruptions of the business models and, finally, ELind seems to have discovered the niche space where it intends to be a leader.

Started in 1990 as a software integration firm by two engineers, Mangal Shetty and K N Prakash, the company was engaged in building small applications for a diverse group of customers. In 1995, when the Securities Exchange Board of India (SEBI) announced the roll-out of regional exchanges, Shetty was quick to sense the opportunity before him. All he had to do was redefine Elind’s strategy. Elind transformed itself into a financial software provider to brokerage firms and exchanges.

By 1996, Elind had successfully developed and deployed an automated equities trading system for the Mangalore Stock Exchange. Its initial success led to more customer wins. In the next couple of years Elind’s team implemented screen based trading technology in three regional stock exchanges. It also developed an order routing and risk management product to the National Stock Exchange.

Having gained significant presence and visibility within the securities industry in India, Elind made a significant foray into the international arena with successful implementation at Abuja Stock Exchange in Nigeria and Trading Lab in Milan.

In 2000, the company spent a lot in building exchange products that provided enhanced features to the depository. What didn’t occur to Elind’s management at that point was that the exchange technology itself is a small market and it is really not worth creating a business plan for that market. “There are about 400 exchanges in the world. Of these top-tier exchanges don’t even talk to you unless you are big. Our business model was flawed in a sense,” says a candid Shetty.

Elind received $1.3 million from Intel Capital in September 2000. Its next step was to foray into the U.S securities market. The company’s manpower had increased from 40 to 150. In 2001, Shetty set up an office in Manhattan. Just when he was writing a blue print for Elind America, the September 11 incident took place. “There was no scope for an exchange product—even to get a small product deal was remote. Our survival was at stake. All the build-up we had done had to be toned down—we changed tactics and started downsizing back in Bangalore,” says Shetty.

The company presently employs 60 people between the U.S and India, commencing its U.S operations again in November 2002. Since the establishment of Elind’s U.S presence, Elind’s revenues have increased from $700K to $1.8 million. Elind expects to grow revenues to $61 million by year 2009.