Regulators and users alike are working to break down the barriers between world exchanges in a fight to open up the market and reduce costs, writes Frances Maguire.
As commercial service providers, the world’s securities exchanges are coming under fire from their regulators and their users, which are both trying to lower costs by creating a competitive level playing field.
This is more keenly being played out in Europe, where the introduction of the single currency spelled the end of the need for a domestic stock and derivatives exchange with a captive market in each country in the eurozone.
However, now the globalisation of exchange trading has rapidly forced consolidation on both sides of the Atlantic to achieve the economies of scale needed to compete on a global level.
While the Markets in Financial Instruments Directive (MiFID) has dramatically redrawn the role of exchanges as trading venues in Europe and provided a way in for banks to build multilateral trading facilities (MTF), the code of conduct for clearing and settlement is attempting to build a horizontal infrastructure in Europe by linking clearing houses and settlement agencies.
Knock-on effect
Werner Frey, managing director of the European Securities Services Forum, an affiliate of the Securities Industry and Financial Markets Association, sees a clear impact of what is happening on the trading side.
He says: “As trading becomes more competitive, so too will the clearing and settlement. Under the code of conduct for clearing and settlement, users should have the choice on where to clear and settle trades, irrespective of the trading venue.
“A fully competitive landscape must match the criteria of an attractive business case and user demand as outlined in the access and interoperability guideline. It does not make sense to develop a competitive offer that no firm will make use of.”
He says that it is not about redesigning the infrastructure but opening up the existing one.
The vertical structures being built by the exchanges to offer trading, clearing and settlement must behave in a horizontal manner in offering interoperability and unbundled services as outlined by the code.
“I very much doubt we will see a newly built infrastructure at this stage, it is about making the existing one compete and open up,” says Mr Frey.
Trading venues
“The users have taken the decision to create their own MTF trading venue, but competition came into play when they asked for offers at the clearing and settlement level,” he adds.
“In both cases, they will come from existing service providers, and EuroCCP and the settlement organisations have signed the code of conduct and agreed to offer interoperability and compete on a level playing field.”
Lines are being blurred as both exchanges chase over-the-counter (OTC) business and the OTC market seeks to becomes more transparent, and move towards the central counterparty model.
Data provision, once a staple revenue stream for exchanges, is also no longer just being supplied by exchanges, with more than 22 leading investment houses using Markit BOAT since November 2007 to meet their OTC equity pre- and post-trade MiFID reporting obligations. It will be interesting to see how the exchange market evolves this year.
A changing model
Despite the transformation of the role of securities exchanges during the past few decades, there is little doubt that the model will continue to evolve. At the heart of this change is the fundamental truth that exchanges would not exist if it were not for the banks. And yet, the model where banks report their trading activity to an exchange, only to buy back this data, remains.
On the derivatives side, the battle still rages about true ownership of the open interest generated by exchange-traded derivatives instruments, with both the banks and exchanges staking a claim.
Now that banks have started forming consortia to create their own marketplaces, it does appear that exchanges have come full circle.
It remains to be seen whether banks are backing exchange-like consortia in an attempt to drive down exchange costs, and whether this will lead to a genuine return to member-owned exchanges.
Competitive pressure
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Anthony Belchambers, chief executive of the Futures and Options Association in London, believes that the growing number of bank-led execution platforms is a direct result of competition pressures resulting from overlapping business models and opportunities offered by globalisation and technology – and, in some cases, a deterioration in relations between exchanges and their members. |
Mr Belchambers says: “In some cases, this relationship has increasingly become a tug-of-war for order flow because some exchanges look to disintermediate the traditional broker-dealer intermediaries and attract end-user business directly into their markets, and some financial institutions seek to deliver competing exchange services to their customers.”
Deconcentration provisions
According to Mr Belchambers, the capability of financial institutions to compete with exchanges has been enhanced by the MiFID directive in so far as its deconcentration provisions mean that orders may no longer be required to be executed in the central market, and MTFs now have an EU ‘passport’ comparable to that originally afforded to exchanges under the Investment Services Directive.
However, he adds: “It remains open to exchanges to deploy their existing infrastructure to set up their own competing MTFs.”
Mr Belchambers, in noting the traditional distinction between the US and UK exchange attitudes to the OTC market, points out that, in some respects, service delivery has become less competitive and more complementary.
He says: “In the US, the OTC market has often been viewed as a competitive market to the exchanges, whereas in the UK, it has been traditionally regarded as a complementary market.”
Mr Belchambers adds: “To some extent, that has changed because exchanges have moved progressively away from listing competing OTC instruments and have focused instead – and very successfully – on offering clearing and back-office services to support the OTC market.”
Cutting costs
Turquoise, headed up by Eli Lederman, is set to launch in September. The MTF will be a proxy pan-European stock exchange, designed by nine major investment banks and aimed at cutting dealing costs by 50%.
The hybrid system will allow trading both on and off exchange by integrating dark and transparent pools of liquidity to generate price improvement, transparency and efficiency, and in recognition of the fact that banks backing the venture are some of the largest internalisers.
The launch of Turquoise, an independent company that will provide a pan-European, open trading platform, treating all participants equally, is set to dramatically change the competitive exchange landscape once again.
Backed by the largest investment banks in Europe, Turquoise will have a critical mass of natural liquidity from day one. Whether the exchanges take note remains to be seen, but by voting with their feet, banks can make it very clear that the needs of their customers must take priority over shareholders for the exchanges to survive this latest onslaught.
