Market calls for clearer split of trading activity – The TRADE Poll
A third of the industry believe
separating prop trading from other market making activities would do the most
to improve investor confidence in equity markets, according to the results of
the latest TRADE Poll.
When we put the TRADE Poll together last month – asking the
question ‘What measure would do most to improve investor confidence in equity
markets?’ – perhaps we should have offered the answer: ‘Anything that stops
further embarrassing screw ups by the big banks’ because the parade of shame
continued in July with Barclays (and others) caught manipulating LIBOR and
Britain’s Financial Services Authority finding Barclays, HSBC, Lloyds and the
Royal Bank of Scotland missold interest rate swaps to thousands of small
businesses. The result has been that instead of increasing consumer confidence,
most consumers think banking is a confidence trick.
In June’s poll, market sentiment essentially moved in
a similar direction, with 33.3% of respondents voting that separating prop
trading from other market making activities would do the most to improve
investor confidence in equity markets.
Along with the third who wanted to separate prop trading,
another 28.57% of respondents believed ring-fencing retail from investment
banking was necessary to improve confidence. The issue, one market surveillance
operator said, is one of trust and the separation of practices which the public
find suspicious or too complex to understand.
“Inciting retail flow back to the market will only happen through
improving market perception and confidence, and I question whether or not the
industry is actively doing enough to improve the situation,” he said. “All
we’re getting from regulators at the moment is talk. They are great at going
out there and doing the PR bit, but when it comes the to nitty gritty, nothing
is being improved.”
He contends that the FSA market surveillance system is
flawed and the only way they can detect market manipulation is through market
participants informing them about it.
“When you come to the banks, they do not want to put an
industry standard forward, as that would be creating greater cost and ‘issues’
for them,” he said.
Benoit Lallemand, senior research analyst at Brussels-based
public interest group Finance Watch, agreed the culprits undermining the
confidence of long-term investors in the stock markets were improper mixes of
flow – whether it be prop and market making, or retail and investment banking –
but in his mind, all roads led back to the increasing obsession of exchanges
with proprietary trading firms that engage in high-frequency trading (HFT).
Pointing to the structure of the stock markets, Lallemand
suggested that since Europe’s exchanges had become privatised, they had moved
away from the member-owned structures they once held, thus relinquishing their
focus on providing valuable services to the real economy and instead
concentrating their resources on winning profits from lucrative HFT business,
at the expense of all other market participants.
“This makes a huge difference – despite representing only a
couple of a per cent of the exchanges' customers, HFT is their main client
base,” he said. “This is not in the interests of long-term investors. We need a
market with all types of liquidity, not just a market that caters for a few. As
it stands, the high-frequency traders are extremely damaging to investor confidence – they are
driving people out of the market.”
In last month’s survey, 22.86% of respondents believed maker-taker
venue pricing needed reforming. Lallemand believes the role of HFT firms as
market makers should be re-examined. While old-fashioned market makers were
subject to various constraints and obligations as part of agreements to provide liquidity, many current HFT market making firms do not sign such agreements and are not bound to provide firm quotes nor remain in the
“Market makers increase confidence in equity markets only
when they have obligations and restraints,” added Lallemand. “HFT market makers
make markets while also taking liquidity. There is a conflict of interest with
these players who are supposed to serve you, but are actually combining that
activity with predatory strategies that make a profit at your expense.”