The new trading platforms that compete against established exchanges to match orders are having a clear and profound impact on the European trading landscape. Chi-X, the first of a growing number of pan-European MTF to have launched since the EU’s Markets in Financial Instruments Directive (Mifid) came into effect, now regularly handles more than 15% of the total volume of FTSE 100 shares traded, while Turquoise, a rival MTF initiated by a group of investment banks that launched in August, has already captured almost 5% of that market.
The investment banks that have been the driving force behind these platforms are thrilled. Analysts estimate that the amount that banks have invested in such platforms is already dwarfed by the amount they have saved through lower exchange fees. Citi recently said that it now does more than half its trades on Chi-X and Turquoise.
"Equity trading in Europe is an evolving landscape and it is clear that the wholesale changes we are seeing will be an uncomfortable ride for many," says Miranda Mizen, an analyst at consultancy Tabb Group. "Exchanges are under pressure and this will get more intense and force them to become more like their new competitors who have significantly lower cost bases. Expect price wars and for exchanges to get hurt more by them than MTFs because they have more to lose and because they are more sensitive to profitability."
Despite their market share successes, MTFs are not indulging in an excess of rejoicing, because overall trading volumes have fallen in recent months.
"Volume and volatility have decoupled, which is something you do not ordinarily expect to see," says Eli Lederman, chief executive of Turquoise. "Volatility is usually a good thing for exchanges and trading platforms, at least in the short term, but the market is now seeing overall trading volumes considerably lower despite the epic volatility. This is down partly to volume being measured in notional value and all stocks are worth less, and also that a number of major trading participants either no longer exist or are just sitting on the sidelines."
Volatility has also put to the test the commitment of some MTF backers. The nine investment banks backing Turquoise, which also committed themselves to providing market-making on the platform, have negotiated temporary relief from their responsibilities for times when volatility reaches extreme peaks.
The profitability challenge
Profitability for MTFs remains a challenge, although not a terribly pressing one so soon after launching, as most are still more focused on building market share. Chi-X recorded its first profitable month in September 2008 after capturing 22.36% of the trading in FTSE 100 stocks and executing a total volume of stocks of €256 billion.
The announcement gives an indication of just how much business MTFs need to win before they can be profitable, although not all charge as little as Chi-X, and of how hard it will be for all the MTFs that have launched – 18 in number and rising – to carve out profitable niches in the market. Not all can succeed but a well-defined niche rather than size alone is likely to be a key determinant of success.
This November, SIX Swiss Exchange finally pulled the plug on its London-based SWX Europe MTF, which had been operating under various names for years without much success beyond its core market of Swiss blue chips. The Swiss Exchange operator announced that it would reunify trading of Swiss blue chips on its home exchange in Zurich from mid-2009, a move that will simplify regulations for customers and realize substantial cost savings.
Plus Markets Group, which operates a rival London exchange that runs a quote-driven trading platform targeted at retail brokers – a neglected community whose trading needs differ substantially from those of bulge-bracket investment banks and hedge funds – this November announced that the number of trades it executed in October had risen 45% in one month. Plus claims to be the leading exchange in the UK for retail orders and to have a market share of more than 50% for 763 small and mid-cap stocks.
Plus also announced that it had extended its network of overseas partners to include Direct Edge ECN, the fourth-largest equities market centre in the US. The two companies will jointly examine the potential for cooperation on transatlantic listing and trading opportunities. Plus is also working on a pan-European market for smaller companies with the Munich Stock Exchange.
The success of certain dark pool trading systems and internal broker crossing systems has also been attracting the attention of regulators, including the UK’s Financial Services Authority, because of concerns about the extent to which they might be playing a role in price formation.
Dark pools have different market models, some of which are price-taking and therefore of no concern, such as Posit, while others involve some element of price discovery, such as Liquidnet, which uses bilaterally negotiated prices. One of the goals of Mifid was to increase transparency and there are concerns that having a high proportion of trading taking place on dark pools could affect transparency and the quality of price discovery in the market as a whole.
"It may not be the best time in the world to start a trading platform but then again it’s not the best time to launch a restaurant or a dry cleaner either," says Lederman.