Nine months ago the Equiduct story seemed to have come to an ignominious end. The trading platform, which had planned to resurrect the old Easdaq stock exchange infrastructure to take part in the new post-MiFID era of bourse competition, had grand plans. But with the fanfare that accompanied the announcement of Turquoise, the bank-backed platform, and the successful launch of Chi-X, Equiduct struggled for credibility and for cash.
Also threatened with obscurity by the likely consolidation of the large, technocratic exchanges across Europe was the 323 year-old Börse Berlin, which has quietly operated in the shadow of its neighbour in Frankfurt. “Börse Berlin is a regional exchange, and it’s not a secret it was not very successful,” says co-CEO Artur Fischer. Mr Fischer had worked on the Frankfurt exchange, helping to put in place the DAX, and later worked with Börse Berlin and Nasdaq in the creation of the Nasdaq Europe, one of Easdaq’s later guises.
“We have existed for 323 years, so we were able to put some money away. We used that funding and we bought the majority share of Equiduct.”
Mr Fischer lacks the grandstanding style of some of his competitors, who have taken the stage at conferences wielding boxing gloves, or prophesised the start of “bloody wars” between exchanges. But he does believe that, in meshing some of the ideas left over from Equiduct’s launch with his own, he has created the next generation of the stock exchange. He is also highly complementary about the competition.
Incentives to market makers
“The temptation to use the name of a competitor like Chi-X is that they have proved to the world that somebody who exists for two years can attract 160,000 trades a day,” he says. His own venture, now known as Equiduct Trading, will be using some of Chi-X’s incentives to market makers, including incentivising market makers. Market making on Equiduct will be free. Chi-X, currently, offers rebates, and Mr Fischer says that his shareholders have permitted him to follow suit, once he has the money available to do so.
“The key competency of an exchange is that you have a fair and a competitive price discovery mechanism, and a fair and competitive price discovery mechanism is to do with providing liquidity. That liquidity will attract other orders, either institutions or retail orders. It’s a chicken and egg problem. [Chi-X] managed to do that first with the pricing and then with a fair approach to attract liquidity providers and then, after that had been done, they attracted quite a lot of institutional flow.”
Equiduct will run a hybrid order book like its competitors, but Mr Fischer has no illusions about that element. “That’s a pure me-too product and a marketing initiative, but I can’t see that for the next number of years that it will generate any substantial profit.” Where he does hope to differentiate is through an initiative dubbed PartnerEx, which will introduce a system not dissimilar from the trade through rule that operates in the US. There, the exchange bears responsibility for best execution in a fragmented liquidity environment whereas in Europe the broker is accountable.
Natural evolution
Using a product from Fixnetix, a technology vendor, Equiduct imports the order books of the London Stock Exchange (LSE), Euronext, Chi-X and Xetra. “I import, in real time, those level two order books, and if a client order comes in, I simulate executions across those four execution venues. The simulation shows me what a smart order router would achieve on all those four trading venues.” This is the natural evolution of the stock exchange, Mr Fischer says.
“When you had the broker and floor trading, the price finding mechanism was in the hands of a few specialists who more or less owned the price discovery mechanisms. It was a specialist in the pits at the LSE, who would run around and try to find the best price. Now, with electronic trading systems like Xetra, that is not any more in the hands of a few people, it is in the hands of the exchange, which, by setting up the technology, has taken a much bigger influence in the price discovery mechanism, and has a much more deciding influence in the quality of the offering.
“In PartnerEx we convince the market maker that we set the price at which he will deliver the equity. That is unique. I don’t know any other system where the market maker allows the exchange to set the quote machine and determine the price at which he will deliver.” While a market maker may get a smaller spread, he is guaranteed a fair price of execution, Mr Fischer says. Equiduct anticipates that systematic internalisers are likely to form a large constituent of the market making community on PartnerEx, as the system solves the problem of managing the value at risk on the market position a systematic internaliser builds up in the process of trading.
“If somebody has decided for himself to become an internaliser, he will automatically be very happy to participate as PartnerEx market maker in my system, because I charge him nothing, I pay for all the technology, and I deliver in real time a spread to him, albeit small, and at the same time, I diversify his market position and reduce his value at risk,” he says.
The model should have benefits for the buy-side too. “If I identify an order flow provider, I actually generate a B2B relationship between the market maker and the order flow provider,” Mr Fischer says. “And to all of the providers I will make available more than one market maker, it is quite possible that an order provider has three or four market makers that then compete against each other. And they can compete by either price improvement, by volumes, or by clearing and settlement locations.”
Clearing and settlement is a further differentiator between Equiduct and Chi-X. While Chi-X is working with Fortis on a clearing layer, Equiduct has gone straight to the clearing houses in its core markets – LCH Clearnet in the UK and in France, and Eurex CCP in Germany.
“In the PartnerEx model, market maker and order provider decide on an instrument level where they do clearing and settlement, so they can maximise and leverage their existing infrastructure. Banks have different connectivities to post trade infrastructures, with the flexibility to have a choice, they can come up with a fine tuned set of relationships which give immense cost savings in the post-trade infrastructure.
“If you look at what Chi-X has done with Fortis, I believe that their way of becoming a pan-European exchange is actually more expensive, because it introduces a middle layer. They put Fortis in between all the clearing and settlement agreements, and that separate layer is costing you extra. They hide that very well, they’re very clever.” The gloves are still on, but the jabs have already begun.
KEY FACTS
- Borse Berlin bought the majority share in Equiduct and launched Equiduct Trading.
- The PartnerEx initiative will introduce a system similar to the trade through rule that operates in the US.
- Equiduct will go straight to the clearing houses in its core markets, avoiding the middle layer used by Ch-X.
