Chi-X fate to shape Europe's derivatives landscape

The outcome of the current bid speculation surrounding Chi-X Europe, the largest pan-European multilateral trading facility, could fan the flames of an already heated battle between Europe's primary exchanges for derivatives volumes.
By None

The outcome of the current bid speculation surrounding Chi-X Europe, the largest pan-European multilateral trading facility (MTF), could fan the flames of an already heated battle between Europe's primary exchanges for derivatives volumes.

In late August, Chi-X Europe confirmed that it had been contacted by an unnamed party in a move that may lead to an offer for its platform. BATS Europe is widely believed to have made the approach, although exchange groups Nasdaq OMX and Deutsche Börse are also thought to have expressed an interest.

Launched by agency broker Instinet in March 2007 – and now co-owned by more than a dozen banks and high-frequency trading firms – Chi-X Europe's initial goal was to challenge the secondary equities trading monopolies held by Europe's domestic exchanges. But the competitive landscape now seems to be morphing, according to Steve Grob, director of strategy at trading technology vendor Fidessa.

“Whereas phase one of the trading venue battle was MTFs versus primaries, it's now primaries versus primaries, and BATS Europe and Chi-X Europe are firmly involved in this fight,” Grob told

As well as competing with each other for pan-European equity trading business –Turquoise MTF, owned by the London Stock Exchange (LSE) since February 2010, faces off against by NYSE Euronext's Arca Europe and Xetra International Market of Deutsche Börse in this arena – Europe's large domestic exchanges are ramping up their derivatives trading capabilities and battle for international listings. While Deutsche Börse's Eurex (co-owned with SIX Swiss Exchange) and NYSE Euronext's Liffe are established leaders in exchange-traded derivatives, tougher regulation of OTC derivatives is creating a wide range of new opportunities for European bourses. LSE CEO Xavier Rolet announced at the recent FIA/FOA International Derivatives Expo that the exchange plans to offer pan-European equity derivatives within nine months.

In equities, the successful capture of Chi-X Europe – which accounted for 17.2% of European market share in August 2010 according to Thomson Reuters – could be the knock-out blow that leaves one incumbent exchange pre-eminent in pan-European trading. With its equities strategy suitably bolstered, the victorious exchange could concentrate its energies on building, or defending, its derivatives business.

But a merged Chi-X/BATS – or the continued pursuit of an independent strategy by Chi-X Europe – could open up a new front for competition between MTFs and exchanges. According to a spokesperson for Chi-X Europe, the MTF is already working on a derivatives strategy and will make more details public before the end of the year.

“A BATS and Chi-X combination would create a new challenger to exchanges on a global scale,” commented Hirander Misra, ex-COO of Chi-X Europe and currently CEO of technology vendor ALGO Technologies. “MTFs are likely to be led by their cash equities business, but Chi-X Europe's customer traction combined with BATS' faster platform and multi-asset capabilities would create a viable proposition to compete with global exchanges.”

“A deal between Chi-X and BATS will obviously create synergies and not just in terms of technology. This would hopefully enable the merged entity to become more profitable longer term – something most MTFs have struggled with to date,” added Andrew Wells, head of equity business strategy, Citi.

In addition to its US and European equity markets, BATS also launched an options market in the US in May.

But Misra cautions that challenging the dominance of incumbent derivatives exchanges will be a much harder task than gaining market share in cash equities.

“Fragmentation has proven liquidity isn't sticky in the cash equities markets,” said Misra. “The hardest thing in derivatives will be shifting open interest because interoperability in clearing isn’t envisaged in that space for at least three years.”

Exchanges are now increasingly looking to establish vertical silos across clearing and trading to become more competitive in derivatives trading. NYSE Euronext revealed plans to build its own clearing houses by 2012 ditching its relationship with LCH.Clearnet in the process, while the LSE has also said it is putting its own relationship with LCH under review.

Some market participants have indicated that they would prefer that Chi-X Europe did not become part of this inter-exchange battle, but rather remained an alternative venue to prevent a reversion to pre-MiFID monopolies.

“If an entity like Deutsche Börse or Nasdaq OMX bought Chi-X, the concern will be whether we go back to where we were four or five years ago,” said Citi's Wells. “Both BATS and Chi-X are very dynamic and more responsive to change than many exchanges, so there seems to be more potential for MTFs to provide better services.”

Grob adds that the increase in pan-European market share that would result from a Chi-X/BATS partnership could see more equity trading migrate to MTFs. According to the Fidessa Fragmentation Index, an on-order book analysis of global equity trading, BATS Europe and Chi-X accounted for 24.02% of pan-European equity trading in the week ending 24 September, just slightly smaller than the 27.29% amassed by the LSE Group across its UK, Italian and Turquoise trading operations.

“When the LSE had its last outage, the lack of a pan-European consolidated tape saw trading stop on MTFs,” said Grob. “I think investors would be comfortable trading on a BATS and Chi-X combination in the event of another outage.”