The battle for a share of equity trade flows between alternative venues, given that primary sources continue to experience leakages and the occasional technical glitch, is likely to intensify into 2010. Though we could see the first casualty too, as the business models of multilateral trading facilities (MTFs) come under severe pricing pressure, especially where dark pool or non-lit orders are concerned.
The outlook for Europe’s MTFs is certainly a mixed one, with the belief that post-MiFID, fragmentation could be nearing some sort of conclusion as the industry assesses the longevity of its business models. For example, few MTFs have made any money in 2009 and this depressing scenario will not change over the next 12 months, experts predict.
But there could be some light for European providers from darker sources of liquidity, according to new research from the Tabb Group, a US-based consultant. Trading in dark pools is estimated to be at 4.1 per cent of the daily turnover in major European markets at the moment, and this will rise to 7 per cent in 2010 as the buyside acquires the skills to trade “where they cannot see”, though this is pending regulatory approval in Europe (and the US).
According to Miranda Mizen, a principal at Tabb, the regulatory review in Europe should add clarity once complete, and remove the ambiguity around dark environments, thereby anchoring dark trading as a legitimate alternative that complements the ‘lit’ markets.
“Regulation may restrict unfettered expansion of dark environments by raising the bar on competition, but it will also marginalise those with paltry liquidity,” she says.
Current reporting standards, the spectre of a regulatory review and lack of volume in some, have created uncertainty about how much volume is traded “in the dark”.
Tabb estimates there are 33 dark pools operated by a combination of brokers, lit MTFs and exchanges, but the large choice “does not de facto add to the quality of the dark environment.” Unless regulation becomes a barrier, Tabb says the number of dark environments will continue to increase, but “as liquidity splinters, this will work against the buyside as liquidity becomes harder to find without leaking information” – and this increases the need for smarter aggregation. In other words transparency – especially around consolidated tape, where traders can see all the prices and data for all venues in a single place – has not necessarily increased as a result of the alternative trading venue explosion.
One issue is that price promotions, which all the MTFs have initiated in recent months to strangle competition and win trades from the incumbent destinations, could come back to haunt them.
“Chi-X, Bats, Turquoise… all of these MTFs have had an impact on latency, efficiency and the cost of trading, and it has been healthy for the market overall,” admires Richard Balarkas, president and chief executive officer at Instinet Europe, the agency broker. “However they are also adept at killing each other and they appear to be beating themselves over the head (on pricing), and we may see consolidation as a consequence.”
This quarter, both Bats and Chi-X (via Chi-Delta) have consolidated dark pool pricing to 0.15 basis points for a single transaction. Bats said in a client statement: “Feedback was that while they appreciated the innovative approach of utilising maker-taker pricing in the dark pool, clients found a single trading fee much simpler to explain to their own customers.”
Chi-Delta claims clients have reaped price savings of €2.7m for non-lit trades as a result of its 2009 promotions.
Breakdown
Steve Grob, director of strategy at Fidessa, a trade services provider, has studied the trading patterns of Europe’s venues and has produced the Fragmentation Index, which claims to measure how trading has begun to fragment across established venues like the London Stock Exchange (LSE) and migrated to the likes of Chi-X and Bats Europe.
“My research shows that the change in (the growth of) trading fragmentation has not slowed, and so MiFID has actually done its job in terms of unravelling the monopoly of the primary venues,” says Mr Grob. “But the real question remains ‘who is actually benefiting from this fragmentation?’”
Fidessa’s index shows the LSE’s share of UK equity trades fell from 68 per cent to 35 per cent between June 2008 and October 2009. Chi-X’s grip went from 8 per cent to 13 per cent during the same period and, significantly, MTFs and non-lit venues now account for around 40 per cent of activity.
Going deeper, the index reveals Chi-X is making the most ground on primaries of any MTF for London trades, and logically it is in the best position for 2010’s renewed offensive. Around a quarter of FTSE 100 shares went via the trade order book of Chi-X, up from 15 per cent this time last year, with trades in Unilever and BP particularly popular.
Bats Europe, an MTF headed by Mark Hemsley, has also steadily added to its share of orders for FTSE 100 names. For example, one in 10 of Diageo trades went through Bats for the week ending December 4.
But there are issues other than the obvious one of competition, which is making for a tough winter for Europe’s non-primary destinations, explains Mr Hemsley. “Attracting liquidity is becoming increasingly important for MTFs and the clearing environment in Europe – which is expensive and clumsy at the moment – which makes it a harder challenge than in the US,” he says.
Complicated clearing is classic angst territory (that, and the lack of a consolidated tape) for MTFs in Europe. In the US, trades are cleared via a relatively monopolistic, inexpensive environment, making the order routing of trades that much easier and faster. Trades therefore tend to make their
