Europe’s largest stock exchanges have so far struggled to stem the tide of market share flowing to multilateral trading facilities (MTFs) since the introduction of MiFID in November 2007.
With several exchanges arguing that the directive has created an uneven playing field, for example through lower risk management burdens, will the European Commission’s upcoming review of MiFID offer an opportunity for incumbent bourses to swing the pendulum back in their favour? Or alternatively, should they continue to expand beyond secondary market trading into areas that have so far been left untouched by alternative trading venues?
According to data from Thomson Reuters, the top three European stock exchanges – the London Stock Exchange (LSE), Deutsche Börse and NYSE Euronext in Paris – accounted for 56.3% of the €1.41 trillion in Europe traded in January 2008. Fast-forward to May 2010 and the same three exchanges accounted for 38.45% of the €1.1 trillion total. Chi-X Europe, the largest pan-European MTF, accounted for 16.9% of total European trading in May 2010.
Far from accepting a diminished share of secondary market trading, the incumbent exchanges have taken the fight to the MTFs. The LSE – which derived 21.2% of its revenue for the year ending 31 March 2010 from UK and Italian cash equities trading – purchased bank-owned MTF Turquoise at the start of this year, while NYSE Euronext and Deutsche Börse both opted to build their own pan-European trading platforms.
The exchanges also believe they have the ammunition for a battle with regulators.
“We believe the fee structure of our cheapest competitors is unsustainable, especially if one considers that they continue to operate at a loss despite the massive regulatory subsidy they enjoy,” said Xavier Rolet, the LSE’s CEO at the firm’s recent preliminary results presentation in May. “Chi-X Europe, for example, pays an annual regulatory fee that is, like for like, 35 times less than ours – we believe this is unsustainable in the context of the MiFID review.”
Most MTFs have opted for a maker-taker pricing structure, which charges for aggressive order flow, but rebates users for passive order flow. This means MTFs such as BATS Europe and Chi-X Europe make just 0.1 basis point per trade assuming a 50/50 split of passive and aggressive flow.
Submissions from exchanges to the Committee of European Securities Regulators’ (CESR) MiFID consultation paper on equity markets, the outcome of which will be fed into the EC’s impending review of the directive, suggest exchanges feel that the rules created to introduce competition need appraisal in light of the MTFs’ ability to win market share without turning a profit.
“The absence of a level playing field between MTFs and [regulated markets] is … mainly due to the light touch in terms of supervision benefiting the MTFs due to the challenger position that they occupy,” wrote Nasdaq OMX, operator of domestic exchanges in Copenhagen, Helsinki and Stockholm, in its response to CESR.
“Markets are being systematically unbundled by venues that are operating unviable and unprofitable commercial models. A clear view on the impact of payment for order flow on market quality and investor protection is missing,” wrote SIX Swiss Exchange in its response.
“We cannot see how such practices are allowed and are consistent with regimes for treating all customers fairly.”
The merits of these arguments could be debated long into the night, but instead of trying to claw back secondary market revenue through regulatory review, exchange groups should perhaps concentrate on developing other related services, i.e. those that the MTFs have not yet touched. In fairness, this one-stop trading shop approach is already taking hold. NYSE Euronext announced in May that it will ditch incumbent post-trade provider LCH.Clearnet before building its own clearing houses in London and Paris by 2012. The LSE has also said it is putting its own relationship with LCH under review, possibly before developing a similar vertical model with CC&G, the Italian clearing house it purchased as part of its takeover of Borsa Italiana just over two years ago.
The LSE’s Rolet has also indicated that the exchange will expand its range of value-added derivatives offerings in the coming year, while NYSE Euronext believes a vertical clearing model will help its own NYSE Liffe derivatives exchanges compete with similarly structured rivals such as the Chicago Mercantile Exchange and Eurex. Eurex’s part-owner, Deutsche Börse, has perhaps adopted the most diversified strategy by acquiring market information and machine-readable news providers, and entering talks to purchase an agency brokerage. To an extent, the exchanges are fighting on two fronts: deploying a rearguard action to protect existing supply lines while sending out expeditionary forces to conquer new territory. Which is just as well as it may be too much to expect the Brussels to rewrite the terms of engagement so soon after unleashing the forces of competition.
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