European mindsets must change to reap MiFID's benefits

Anyone who complains that the first year of MiFID has not driven sufficient change through Europe’s equity markets is in need of a slight reality check, according to Miranda Mizen, senior consultant at Tabb Group, the research and consulting firm.
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Anyone who complains that the first year of MiFID has not driven sufficient change through Europe’s equity markets is in need of a slight reality check, according to Miranda Mizen, senior consultant at Tabb Group, the research and consulting firm.

“Trading without seeing the print is one thing to get used to, trading in the dark is quite another,” she says.

Certainly it’s been a tough few months for advocates of new trading practices and venues in Europe. On 8 September, an outage at the London Stock Exchange resulted, after a brief spasm, in a near-total shutdown in UK share trading, rather than a transfer of trading activity to multilateral trading facilities, such as Chi-X and Turquoise. On 15 September, the twin shocks of Lehman Brothers’ collapse and Bank of America’s purchase of Merrill Lynch heralded a period of unprecedented market volatility and heightened concern about counterparty risk. In such circumstances, implementing connections to the latest MTFs, i.e. BATS Europe and Nasdaq OMX Europe, was a priority for very few. Moreover, the infrastructure required to make MiFID work – a pan-European consolidated tape of post-trade data, for example, or smart order routing (SOR) to locate the best price across multiple venues – is immature to say the least.

Given Europe’s starting point, Tabb’s Mizen says we should hardly be surprised at the pace of change. An extremely diverse range on institutions operates across Europe’s varied financial markets and far from all are focused foremost on exploiting MiFID. “The rate at which an investment firm wants its brokers to connect to new venues will depend on the proportion of its investment that is pan-European, rather than domestic,” she says. And inevitably, buy-side firms will adapt to the new European trading infrastructure more slowly in the current environment. “Technology investment is always slower than on the sell-side,” Mizen observes.

While recognising the differences between Europe and the US, Tabb Group nevertheless predicts that Europe’s exchanges will experience liquidity leakage similar to that already experienced by their American counterparts. In the firm’s European Equity Market Structure 2008 report, Tabb forecasts that exchanges’ share of European liquidity will shrink from 67% in 2008 to 48% in 2011, with lit MTFs’ share rising from 5% to 21% over the same period. Broker dark pools and third-party crossing networks are also expected to increase their market share significantly. As liquidity fragments, reliance on tools such as smart order routing will grow.

SOR might be relatively basic at present, but Mizen suggests that it will become increasingly complex as market participants’ understanding of their individual requirements of the emerging European equity market develops. “SOR has some way to go, in terms of sophistication,” she says. “Investment firms need to decide which pieces of their trades really matter: before Lehman Brothers and Fortis collapsed, for example, price mattered more than counterparty risk. Market participants also need to decide whether they trust the order flow in different venues. Only when they have reached a position on these types of issues, based on empirical evidence, can firms begin to instruct SOR with a degree of accuracy.”

Rather than a headlong rush into a new paradigm, Europe is about to engage in an extended period of trial and error, Mizen suggests, in which old practices will be replaced gradually by best execution as it befits individual institutions. “Europe moves at different speeds within itself and the credit crunch has added to an already complex picture, resulting in changes of personnel and budgets, and high levels of economic stress,” she asserts. “It’s hardly surprising that SOR and execution algorithms are not as honed just yet as they might be. There are a lot of ingrained habits and we’re just at the start of a wholesale behavioural change.”

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