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Europe in Pieces: For whom the bell tolls

Published in Automated Trader Magazine Issue 15 Q4 2009

The tussle between national exchanges and MTFs in Europe is hotting up. Who’s going to win? We packed David Dungay off to find out.

For whom the bell tollsWith few exceptions, fragmentation has been steadily increasing across all markets and it sometimes feels as if each week brings a new trading venue. Some have queried whether the playing field is level and if the only course of action for exchanges is to launch MTFs (which they all seem to be doing anyway). So is this the beginning of the end for the primary exchanges? Will their own MTFs only cannibalise their primary liquidity, or will existing MTFs beat them first anyway? Or will MTF investors lose their appetite for bankrolling first?

ROI - who cares?

Capturing market volume is the name of the game and very few are doing it successfully; but Europe is a desirable market and the big investors seem willing to see their platforms through the tough times. Is this loss leading a sustainable way to run a business? Do those investors care?

Probably not, according to Steve Grob, Director of Strategy at Fidessa. "To some extent the investors in the MTFs don't have to worry, the money they get back in terms of improved pricing from the primaries probably more than offsets the money they have to use to top up the bank accounts of the MTFs," he says. So for now the backers look likely to hold firm and stick with the long term view.

Who wants what?

Nevertheless, the next 6 to 12 months are going to be crucial in determining which way Europe organises itself. Everyone is scrambling for a larger market share and the primaries are trying to hang on to what they already have. As Figure 1 shows, some primaries are getting within twitching distance of 50%, which in a two horse race might be considered a potential tipping point. (Remember LIFFE/Eurex and the Bund contract?) However, with a packed field, it's rather less clear what will determine who gets to grab what and when.

Figure 1: Who’s got what?

Figure 1: Who's got what?

Certainty seems to be a major factor according to some. "The ones that are doing well even in times of decreasing volumes are the ones with sustainable business models behind them," says Michael Krogman, Head of Sales, Cash Market Development at Deutsche Boerse AG. "In the end the customer wants to trade on a venue that he can trust and on a venue that will be out there in couple of months."

Steve Grob

Steve Grob

For others, it's all about the plumbing. "Technology is a critical aspect of staying competitive and we regard having control of your own technology as important," says Mark Hemsley, CEO, BATS Europe. "It's much faster to modify the technology; and once you have established that technology and it is well architected, it is less expensive to change."

Fidessa's Grob sees rebates as the MTFs' secret weapon and one that the primaries are less likely to reach for. "Rebates are a huge factor because of the pricing policies that the MTFs are putting out into the market, if the primaries adopted those same polices they might well be accused of anti-competitive behaviour," he says.

In the red corner exchanges, in the blue MTFs

The exchanges have definitely got a fight on their hands, but they are already responding with initiatives such as the launch of their own MTFs. They also have a lot of power in terms of their geographic coverage and their asset class coverage, which they may in time leverage to damaging effect. Furthermore, while they may not (as Grob suggests) adopt the same pricing policies as MTFs, they could try aggregating the rebates they offer across all their markets and asset classes. Exchange club card anyone?

However, the cost of trading is ultimately one of the major factors in determining who comes out on top. Perhaps trying to beat the MTFs at their own game (i.e. being cheaper than a budgie) isn't going to happen, especially when the cost base of the primaries is so high. Some of their MTF competitors have been pleased to remark on this on a regular and high volume basis. Their view is that primaries need to offer more than secondary market trading and in the absence of that they need to rationalise their cost base by sharing technology and management functions, while also consolidating post trade processes.

Michael Krogman

Michael Krogman

Cost bashing is all well and good, but there is regulatory twist here that may make things a little tougher for MTFs. As was highlighted at a recent conference, the regulatory responsibilities for the market fall on the primary exchanges and not the MTFs. The exchanges are also not obliged to inform the MTFs of any new corporate actions or company announcements and this makes some quite nervous. Therefore, when an exchange ceases to trade, people are less willing to trade via the MTFs just in case there is something going on behind the curtain. This also raises some questions around future European regulation. Will that responsibility be taken away from the primaries? If so how will market surveillance take place? Something for MiFID2 to address?

Liquidity my dear Watson

Turquoise being put into play has also thrown the spotlight onto liquidity. If an MTF disappears tomorrow what happens to its liquidity? "I think most people would say it will find its way on to the other platforms, I don't think that the liquidity would just disappear into the ether," says Fidessa's Grob.

Some of our readers are less convinced. "I believe liquidity drops away after a venue disappears," says Jason Rolf, trader at proprietary trading group Ocean Capital Ltd. "The market is finding its own reasons to trade in a way. You see this in the indices in the futures. A huge amount of volume now trades on the Eurostoxx-50 futures and it seems to be where everyone hedges. It is incredibly liquid and I believe the volume has increased to the detriment of a few other indices; I think there is only so much volume to go around."

Michael Krogman

Michael Krogman

Here's a brush…now paint twelve months ahead

The LSE have launched its MTF, Baikal, Deutsche Boerse is about to launch its Pan European Trading Segment and Eurex/ISE have linked up in an attempt to turn the tide. So, twelve months on, who will be left standing?

Not exchanges, according to Ocean Capital's Rolf. "I think some exchanges will go bust; they charge too much and there is too much fat around them," he says. "Another year like last year, with further reduced fee competition from the MTFs, will be the death of a few primaries. They won't be able to sustain themselves and we may see some consolidation among them."

There is certainly more new competition for exchanges on the horizon. An inkling of where this might come from is provided by the recent Optiver/BinckBank announcement of a best execution service that will bypass exchanges completely. On the other hand, it doesn't really make sense for the European market to have too many different trading venues that offer an electronic trading platform for a couple of instruments that everybody trades. Certainly, some see the consolidation story having a wider angle. "You may see some consolidation between the primaries, but I think you will also see some consolidation in the MTF community," says Grob.

So - MTFs have the necessary tools and cost base to potentially succeed in Europe but, with a few exceptions, haven't been able to capture a large market share. Can/will their backers keep them going whilst they are not profitable? Chi-x seems to be leading the field right now among the MTFs but with the exchanges fighting back the jury is still out. Or could Europe sustain yet more trading venues? One thing is for sure, there will be casualties soon - probably on both sides…

As this feature went to press, Turquoise released the preliminary announcement of its exclusivity deal with the LSE. A thought-provoking example of the old swallowing up the new? A sign of deals to come?