Does the latest round of consolidation spell the end of the period of competition between European trading venues introduced by MiFID?
Technically there may be less competition, thanks to the likely takeover of one multilateral trading facility (MTF), Chi-X Europe, by BATS Trading, the parent of another, BATS Europe. The deal would in effect see the largest exchange-independent MTF[1] taken over by the second largest. MTFs have had a hard time, launching as they did at various stages of the financial crisis. After Turquoise failed to perform its parent brokers sold a majority share to the London Stock Exchange (LSE) in February 2010 and Nasdaq OMX Europe was shut down on 1 July for the same reason. BATS Europe has itself lost money, posting a US$10 million loss in 2009 and predicting a US$5 million loss in 2010. Chi-X Europe is the only MTF to claim profitability. Combined with BATS, it could create a highly evolved MTF that sustains competition.
What would the combined entity look like?
Chi-X Europe was the continent's largest single trading venue by volume in 2010, with a market share of 16.6%, according to data vendor Thomson Reuters' Equity Market Share Reporter. If it merged with BATS Europe, which by its own figures averaged 6.2% of the pan-European market, the combined entity could have a theoretical market share of 22%. Based on 2010 figures from trading system supplier Fidessa's Fragmentation Index, it could also take around 20% of all trading in FTSE 100 stocks in the UK and double-digit proportions of trading on other major European indices. BATS Europe has the faster trading platform of the two and matched with Chi-X Europe's customer base that would look attractive to high-frequency trading (HFT) firms. As these firms provide valuable liquidity a successfully executed merger would support the existing levels of trading activity and may grow it.
However few market participants believe that the joint entity would retain the combined value of the both firms' market share, as a lot of trading goes on between the two. Some large HFT firms, such as market maker Getco, are major liquidity providers to both.
How does the market share of the major exchanges compare?
When comparing market share it's worth noting that, unlike MTFs, the incumbent major European exchanges do not trade pan-European stocks on their main markets, only their own national stocks, although all have nascent pan-European platforms, such as Deutsche Börse's Xetra International Market. As such, their largest individual markets account for a smaller slice of total European trading than Chi-X Europe. The London Stock Exchange Group's London market held a 12.75% market share by turnover in 2010, Deutsche Börse's Xetra platform had 12.97% and international exchange group NYSE Euronext's Paris market represented 11.57% of pan-European volume.
However if one takes into account Borsa Italiana and MTF Turquoise as part of the broader London Stock Exchange Group, then it has 24.6% of the European market. NYSE Euronext's Amsterdam, Paris, Brussels and Luxembourg markets combined accounted for an average 17.23% of the market in 2010. Additionally on a national basis they each retain over 30% of volume traded in the stocks of their respective major national indices, according to Fidessa's data, which is typically double that of Chi-X Europe.
So will MTFs be a serious competitive threat to the major exchanges in 2011?
Since MiFID came into effect on 1 November 2007, enabling MTFs to trade stocks on a pan-European basis, the incumbent exchanges have fought hard against their low-cost usurpers to retain market share. The LSE has cut its fees six times, NYSE Euronext four times and Deutsche Börse three times. All three have also introduced new services and technologies to attract high-frequency traffic. Nevertheless, liquidity has moved to MTFs, primarily Chi-X Europe. That pressure should not diminish on the basis of this merger. BATS is unlikely to tamper with Chi-X Europe's winning formula, other than potentially by improving its technology and reducing overall operational overheads. By keeping the MTFs independent of incumbent exchanges (both NYSE Euronext and exchange operator Nasdaq OMX are said to have been bidders) the independent pan-European trading venue is alive and kicking.
Is that good news for the buy-side?
Despite the fee cuts at exchanges, the buy-side has not seen any significant cost savings as a result of pan-European competition so far. The sell-side has seen the majority of the savings and hasn't necessarily passed them on. Asset managers don't appear aggrieved by this, as trading performance is a more important measure of cost for them than reduced fees. And indirectly there is an advantage, as brokers are less likely to increase prices for their clients when their own costs are falling.
Indirect buy-side costs have been increased because fund managers are now connecting to many different venues directly and they are also investing more heavily due to the greater complexity of tracking trading performance. By reducing the number of venues, this deal may reduce costs slightly and price formation will be simpler.
Other MTFs – such as second wave players such as Quote MTF or the recently announced broker-owned MTFs – will try to take advantage of any disruption during any BATS/Chi-X integration period and steal market share from them, while the new venue will itself have to keep ”sticky' to retain its liquidity. The competitive atmosphere and resulting low prices will see lit venues remaining highly attractive in 2011, limiting migration of liquidity to dark venues as a result.
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