The volume and value of shares traded on traditional European stock exchanges dropped sharply this August compared with the same month in 2007. While the slump is to be expected given the abnormal spike last August caused by the onset of the credit crisis, it could prove challenging for exchanges on a number of fronts.
The number of electronic equity trades across the London Stock Exchange (LSE) group fell 9% in August, and the average daily value fell 34%. Deutsche Börse’s volume on Xetra was down 28% and turnover fell 49%. Volume on NYSE Euronext’s European cash markets declined 14.4%.
Research from investment bank Citi shows that this trend was felt beyond Europe – it found that the value of equities traded globally declined 37% in August.
Part of the reason was an unusually big spike in trading activity last August, thanks to the onset of the US sub-prime mortgage crisis, making this August’s activity look muted in comparison. But another explanation is a greater reluctance to trade in today’s conditions.
“An explanation put forward for the decline, but which is difficult to demonstrate in hard numbers, is that it is a reflection of a combination of reduced risk appetite at large banks and potentially reduced leverage and risk appetite and hedge funds,” said Andrew Mitchell, analyst at investment bank Fox-Pitt, Kelton.
Hedge funds in particular may have lost some of their appetite for investing after they were hit by a fall in commodity values in July. The Dow Jones-AIG Commodity Index fell 12% in July compared with the previous month.
“Because of the sub-prime issues, a lot of the hedge funds got badly burned in July, and shut up shop to some degree awaiting redemptions,” said Adrian Fitzpatrick, head of investment dealing at Aegon Asset Management UK. “They will probably come back to the market in late September,” he said.
Lower volumes could tempt traders to transact business on European exchanges’ new rivals. “Lower volumes on exchange means people put more trades into alternative venues and dark pools,” says Fitzpatrick. “If there isn’t the depth of liquidity on the exchanges, people try other venues. That is why you have seen the volume of business on Chi-X go up dramatically, why Turquoise has done well since it started, and why people are putting flow into different dark pools.”
The fall could also put pressure on exchanges’ revenues, particularly in Europe. “The significance of the August decline is that the European exchanges charge predominantly on a value-based fee scale so clearly you have got an impact on revenues from that,” said Mitchell. “The question is to what extent the slowdown will be maintained through subsequent months.”
The longer-term trend, demonstrated by a comparison of year-to-date values in 2007 and 2008, is that the total value of trades is stagnating or falling, while volumes are growing. For example, in the period from January to August 2008, average daily value traded in the LSE’s UK order book increased only 1%, yet volumes were up 45%. And on NYSE Euronext’s European cash markets, values declined 15.8%, while volumes increased 20.1%. This shift is being driven by the growing use of algorithms, which slice orders up into smaller pieces to avoid market impact.
While not necessarily negative for exchanges, according to Mitchell, observers should not expect growing volumes to translate into higher revenues for exchanges. This is because a number of exchanges have recently introduced discounts for firms trading high volumes. On 1 July, for example, NYSE Euronext introduced a new fee structure, called Pack Epsilon, for its European cash equity markets. This allows eligible clients to increase their order flow in Euronext stocks while being charged for the first partial order execution only, rather than being charged for each partial execution linked to the same order. And in September, the LSE moved to a maker-taker pricing model, which pays the most generous rebates and charges the lowest fees to those trading the most value on the exchange.
“Bargain numbers did have more of an impact previously, but various fee structure changes have meant that this per-bargain element of fees, particularly for high-volume users, has been reduced, and LSE’s latest amendment pretty much eliminated that component,” he said.
Declining total trade values could also dampen exchanges’ ability to post the record results they have been enjoying in recent years. “Although the trend is not putting exchanges under any real financial pressure, it is very possible that expectations for the earnings might have to change,” said Mitchell. “They have tended to beat expectations in previous years, so it is quite possible that analysts will get it wrong in the other direction at some point.”
Although declining trade values will put pressure on exchanges, a far bigger threat is competition fro their new rivals. “The challenge they face on the cash equities side is the impact of the MTFs entering the market,” said Mitchell.