Multilateral trading facilities (MTFs) have made inroads into European equities trading and are likely to drive down pricing, and threaten the data revenues of the main bourses.
Four MTFs are now operational in Europe. Bats Europe, Nasdaq OMX Europe and Turquoise have launched MTFs since mid-2008, joining Instinet company Chi-X, which was first off the blocks in March 2007.
Chi-X and Turquoise, which went live last August, had a headstart on the market, and have systematically taken the lion’s share. At the end of the year Chi-X accounted for 13 per cent of trades on FTSE stocks, while Turquoise, which can count on the support of its big bank shareholders, took 6 per cent, according to the Fidessa Fragmentation Index.
Chi-X has had particular success in Euronext Amsterdam where it has taken nearly half the trade in certain blue chips such as Philips. The first-mover became profitable in October, but that month probably revelled in the highest equity trading volumes of all time, and since then volumes have halved.
Nasdaq and Bats have not attracted the same commitment, accounting for 0.8 per cent and 0.36 per cent of trades in FTSE stocks at the year-end respectively.
“One of the biggest challenges is how to get liquidity out to the platform and how to encourage dealers to buy into providing liquidity,” says Harrell Smith, head of product strategy at Portware.
“Perhaps some of the newer entrants such as Nasdaq would have fared better with the backing of the broker-dealer community. The competition is good for pricing and performance but those that succeed will be those that make it attractive to participants, by giving them a stake.”
There is growing concern that the sharp downturn in trading volumes could make it difficult for MTFs to break-even. NYSE Euronext blamed extreme market conditions for postponing the launch of its planned MTF, now scheduled for March, while Pipeline has pulled its launch back from October. There are rumours that Nyfix Millennium is looking for a buyer, while Scandinavian MTF Burgundy has been struggling with settlement and counterparty issues.
Equiduct Trading, owned by Börse Berlin, has pulled its launch back from February. Artur Fischer, joint-CEO, said trading participants are not as prepared as expected, transactions in the marketplace have been shrinking and that the price war among brokers had not helped. Prospective members may have previously been deterred from connecting because Equiduct does not offer access to pan-European central counterparties, such as EuroCCP or EMCF but may now favour three well-established counterparties it can offer.
Market share
“Unless you can catch significant market share, making money is going to be tough in this environment, but the volumes some of these guys are achieving is very small,” says Jerry Lees, head of alternative execution services at Cheuvreux. “We’ve had 29 conversations with MTFs about potential connectivity but many of these different products are now on hold.”
Nevertheless, Europe is only in its first wave of market fragmentation compared with the US. The UK, the Netherlands and, France and Germany are leading the way while some other countries have been slow to implement the EU’s Markets in Financial Instruments Directive (Mifid). Both Turquoise and rival Chi-X have experienced difficulties entering the Spanish market owing to complications related to the country’s Iberclear clearing system.
This fragmentation has created a new demand for Smart Order Routers (SORs), that sweep different execution venues looking for the best price, a process that involves a hierarchy of decision-making criteria based on price, size and liquidity. The best run multi-sweeps will continuously watch all the order books and will adjust any limit orders. Some traders have been slow to capitalise on execution platforms as both price formation and price discovery mechanisms, however.
Lacking investment
The products have also been found lacking. For instance, alternative trading venues failed to benefit from the shutdown of the London Stock Exchange for seven hours on 8 September 2008, because many brokers’ SORs were not configured to take into account that the primary market could go down.
“A lot of SORs aren’t very smart at all,” says Bradley Duke, head of institutional electronic sales in Europe, at Knight Capital. “Many do not re-evaluate the trade through the life of an order on a continuous basis, including some from big name providers.”
“While Tier One institutions have deep enough pockets to pay for this IT investment, Tier Two brokers may struggle with perhaps the exception of BNP, Calyon and us,” says Richard Hills, global head of electronic services, Société Générale.
