Is the market suffering from a lack of concentration?

François Banneville, head of execution services Europe, Société Générale Corporate & Investment Banking, takes stock of market structure expectations post-MiFID.

Prior to the implementation of MiFID, commentators made a number of predictions about the likely shape of the securities industry in the wake of regulatory reform. How far are these predictions being borne out?

The consensus has been that the removal of the concentration rule in Europe will result in more trading venues and consequently greater liquidity fragmentation. Yet old habits die hard. New trading venues such as Chi-X and other MTFs have certainly made their mark and will continue to do so, but we believe the bulk of the liquidity will remain concentrated at the exchanges. A degree of fragmentation is not incompatible with concentration. In the US, despite all the new liquidity pools, four venues still account for some 90% of the equity trading volume.

In Europe, the exchanges are also aware of the need to retain liquidity. In the French market, for example, Euronext unilaterally abolished its ‘first-in first-out’ rule at the same time as MiFID was introduced. In so doing, they were effectively creating their own internalised MTF and giving brokers who were providing liquidity to the exchange the opportunity to cross their own stock in advance of others in the market. Instead of ‘price, time, size’, the exchange’s matching algorithm became ‘price, broker, time and size’. This meant that if you as a broker had both sides of a deal, you could achieve a match through the exchange’s algorithm.

What we do see as a result of new competitive liquidity venues, however, is growing pressure on exchanges and clearing entities to lower their fees. Pricing on Chi-X, for example, is very keen. That is good for exchange members and ultimately for the clients. In a hypothetically pure market, with all barriers removed, including the concentration rule, more expensive national exchanges would see a migration of liquidity to cheaper markets. Given the lack of interoperability across post-trade market infrastructures in Europe, we are not there yet, however.

Connectivity
That said, no professional market intermediary wants to miss an opportunity to capture liquidity, wherever it arises. The quest for comprehensive connectivity will therefore continue.

The cost of maintaining efficient multi-market trading links, combined with the impact of commission sharing agreements (CSAs), is leading to rationalisation in this segment of the market. We see the start of a trend among some smaller sell-side firms to position themselves as introducing brokers, relying on larger firms for market access. At the same time, buy-side institutions are cut-ting back their lists of executing brokers. It is too early to say whether the aggregate commission pot has reduced, but there has certainly been greater use of CSAs, with some specialist brokers beginning to see the attractions of receiving regular cheques rather than waiting for client flow.

Organising service provision
Broadly speaking, most large executing brokers offer several products with different prices, depending on the value added. DMA is ‘no touch’, manual sales trading is ‘high touch’ and program trading falls between the two – ‘low touch’, but not ‘no touch’. We see most of our clients classifying their flows according to those criteria.

What is the impact of these perceptions on the way we organise our desk? The sell-side has, in the past, had a tendency to be organised in silos. The different services would not share their flows and often would not share their customers either.

At Société Générale, we made a decision 18 months ago to put all our cash equity execution teams under one umbrella. Everyone has a set of clients for which they have leadership and for whom they act as execution account managers. It is their responsibility to make sure that each of their clients is covered for all aspects of the execution spectrum.

Within this group we do not internalise flows as such. The perceived risk of internalisation is that some-one will put their book in front of a client order and make money out of it. We do not do prop trading within the cash department and for that reason we don’t internalise.

We do, however, take advantage of concentration opportunities. On Euronext, for example, we use the Euronext matching facility. We put all our flows through Euronext and they do the matching for us. The efficiencies are clear. On one day recently, our maximum crossing level for institutional business using this mechanism was 25%.

On the London Stock Exchange, we chose not to internalise, but to ask all of our prop desks within the equity derivatives department to quote us prices in real time. We are able to use those flows as alternative venues and when the price they offer is better than the exchange, we take it.

This internal structure allows us to be agnostic about the origins of the liquidity we take. We simply have to know that the prices we are getting are going to beat the client’s benchmark. At the end of the day, we still have to prove our execution quality to our clients.