Europe only at start of transition to multi-venue trading

Despite the launch of new pan-European equity venues, September has shown that market participants have yet to adjust fully to the new trading environment.
By None

Despite the launch of new pan-European equity venues, September has shown that market participants have yet to adjust fully to the new trading environment.

On 8 September, a technical problem at the London Stock Exchange (LSE) halted trading for almost the whole day. Contrary to expectations, this did not prompt a shift to alternative venues such as Chi-X and Turquoise. It appeared the market was reluctant to trade without the comfort of the LSE’s pricing mechanism.

According to PJ Di Giammarino, CEO of financial technology think-tank JWG-IT, this indicates that institutions’ business models have not yet adjusted to a market with multiple trading venues.

“At 08.45 on 8 September the volumes on Chi-X were at record levels. When the LSE went down, you would have expected volumes on Chi-X to increase, but in fact they plummeted,” he says. “That tells us that people are afraid to trade without the ‘primary market’, which means they really don’t understand yet or haven’t yet put faith in the fact that a much broader view of 260 execution venues is required. This could also indicate that indices are not keeping up.”

Nevertheless, Giammarino thinks institutions will soon have to adapt to the new reality. “Six months from now, when we have even more venues online, it will no longer be sustainable just to say: ‘we can’t trade without the LSE price’. I expect to see volume shift to the alternative execution venues in the event of an outage. We are going through a big transition now,” he says.

The new multi-venue environment may also force the sell-side to rewrite their execution policies to take account of the multi-venue environment, as buy-side traders start asking more questions about where brokers are executing trades on their behalf. “When the buy-side’s clients start asking them questions, they in turn will need to go back to the sell-side for answers. As more questions are raised, more competitive best execution policies will result, stating multiple venues rather than the limited or single venues that exist in most of today’s polices,” says Jitz Desai, director of JWG-IT. “Instinet’s recent statements about its best execution results are a sure sign that the bar on the sell-side is rising.”

Multiple execution venues are proving a challenge for the buy-side because they have increased the amount of data traders need to process. In addition, many venues are competing by offering trading in finer tick sizes, increasing data volumes still further. If that were not enough, MiFID’s best execution requirements mean that as well as ensuring brokers are doing a good job on their behalf, asset managers also need to be able to prove best execution to end-clients. Therefore, they have to store large amounts of data in case called on to demonstrate how a trade was executed and prove best execution.

In a white paper released in August, ‘Winning the RegTech Data War’, JWG-IT predicted that equity order levels in Europe will leap 1600% in 2009 from today’s levels to 191 million orders a day. A total of 78% of UK and German market participants surveyed by JWG-IT said that overcoming the cost of updated infrastructures and enhanced data quality was more important than their ability to identify new liquidity venues and connect to them.

“In this environment, you can’t afford to fly blind; you have to have your eyes wide open to the challenge,” says Giammarino. “You need to get the metrics in place to be able to ensure that the processes you are relying on to fulfill promises to customers are right for your business. You have to be able to get the kinds of data you need out of the supply chain to be able to support assertions of best execution.”

Unfortunately, collecting, storing and analysing the data required can be costly, particularly at a time when institutions are looking to trim budgets to cope with the increasingly challenging economic environment. “The gut reaction at the moment is to cut costs and keep everything really tight. It is probably the wrong answer if you are trying to understand how you are going to manage the data explosion that’s on your hands,” says Giammarino.