In European equities size matters

Commerzbank, Deutsche Bank and Macquarie have all restructured or exited the equities market as larger institutions maintained their grip on market share.  

The European equities market is set to get even more competitive now as smaller sell-side institutions continue to exit the market and the largest brokers absorb market share. 

For several years shrinking commissions and stringent regulatory requirements imposed on the European market through MiFID II have made it difficult for participants to make equities trading pay. Rising costs have progressively encouraged economies of scale as a necessary means of survival in the market. 

“We’ve seen the market share in Europe has increasingly gone to the big three or four US banks and I think that’s even more notable since MiFID II,” Alex Jenkins, head of the trading desk at Polar Capital, told The TRADE.  

“When I think about the capabilities of the large US institutions, the amount of information analysis they have based on their own data, and the capabilities of their central risk books across asset classes, it’s just vast. I don’t know how you expect any smaller player to keep up with that.” 

Commerzbank was one of the latest participants to bow out of the market, confirming it would shut down its equity sales trading business in February as part of a drastic restructure plan that would see it reduce ‘costly complexity’ across its portfolio. Named Strategy 2024, the plans also outlined the bank’s intentions to cut 10,000 jobs in the next three years. 

“We have already started to review each and every client relationship on its return profile,” Manfred Knof, CEO of Commerzbank, said in a February statement. “In future, we will only deploy capital in client relationships that provide us with a decent return.” 

The bank joined a long list of other sell-side firms that, dwarfed by the giants on the other side of the pond, have chosen to cut their losses.  

Research and regulation 

Ongoing trends relating to regulation in Europe, particularly requirements enforced under MiFID II, have made equities a prickly asset class for institutions to handle.  

In particular, rules dictating how the buy-side consume and pay for research under MiFID II unbundling have had a significant impact on smaller boutique firms that relied on execution to pay for research. 

“We’re no longer in a situation where we can pay for research via execution, and that’s going to have an impact on those houses which in the past have relied on execution to help pay for that research function, particularly some of the boutique guys,” added Jenkins.  

Research unbundling requirements brought with them additional costs that larger firms have been able to absorb more easily, making equities a more profitable business.  

“The process of valuing research, modifying internal systems and communicating the MiFID II unbundling rule changes with clients was a big lift for buy-side firms,” said Anish Puaar, European market structure analyst at Rosenblatt Securities. 

Evidence of the impact of unbundling in Europe is clear from strategic partnerships recently forged in the industry. In late 2019, Kepler Cheuvreux and Macquarie joined forces to form an equities and research alliance. The deal saw the pair launch a platform for equities programme trading, and cross-distribute co-branded equity research to their client bases in Europe and Asia Pacific at the start of 2020. 

At the same time, Macquarie confirmed plans separately to reduce its domestic cash equities presence in Europe and the Americas in favour of refocusing its efforts on its business in Asia Pacific.

New regulatory requirements expected under the MiFID II review have the potential to make equities even more costly for participants with EU regulators keen to focus on a consolidated tape and continuing to encourage trading volumes from dark to lit venues. This will likely accelerate the need for scale seen in the market as participants are expected to absorb additional costs and navigate fragmented trading landscapes following Brexit. 

“That’s [the MiFID II review] going to come with a whole bunch of market structure changes, while Brexit could also pose further complexity as firms grapple with the best way to route orders to UK and EU venues. The recent Treasury consultation includes proposals that will likely result in significant divergence between UK and EU rules,” added Puaar. 

“Larger firms with scale and resources will find it easier to absorb those changes and deal with the regulatory headwinds.” 

SI regime  

The systematic internaliser (SI) regime, which became a key part of MiFID II, has also contributed to the ongoing requirement for scale in the European equities market. 

Trading volumes on SIs operated by brokers and banks have surged in Europe in the post-MiFID II era. A statistical analysis by the European Securities Markets Authority (ESMA) published in November  revealed that SIs had dominated the European equities landscape during 2019. However, the regime favours larger institutions that benefit from big balance sheets and extensive central risk books, allowing large US banks to consolidate market share.  

“The SI regime which says you’ve got to use your own capital again tends to favour firms that are prepared to deploy their own capital when trading with clients. That’s tended to be, not exclusively, the US banks,” said a former member of the sell-side who spoke to The TRADE on condition of anonymity.  

Regulatory changes amending the SI regime under MiFID II, for example relating to mid-point crossing, have also added to rising costs in the equities market that have somewhat excluded the smaller boutique players.  

“Banks spent a lot of time building SIs to meet regulatory obligations such as those related to pre- and post-trade transparency. But EU regulators have continually tweaked the SI rules, such as changing tick sizes and restricting mid-point trading, which requires systems to be constantly modified. These tweaks mean banks always have to be on their toes to remain compliant,” added Puaar. 

This need for scale has forced consolidation across banks and brokers in Europe as the smaller sell-side firms aim to bulk up to keep up with the larger players.   

Most notable was the deal agreed between Deutsche Bank and BNP Paribas in July 2019 in which Deutsche Bank agreed to transition its prime brokerage and electronic equities franchise over to its French rival. The agreement with BNP Paribas came as part of the bank’s restructuring plans that included exiting from equities sales and trading all together under a major restructure plan that aimed to reduce costs by around €6 billion by 2022.  

Through the integration of Deutsche Bank’s business, BNP Paribas said it was looking to become the top prime broker in Europe competing with the likes of Morgan Stanley, Goldman Sachs and JP Morgan.  

The French investment bank also acquired the remaining 50% stake in its long-standing partner and equity brokerage firm Exane in July in a move which brought its cash equities trading and research back in-house. Combined, both deals were intended to bulk out its business as it looks to stake its claim for the top spot as the leading institution in European equities.  

Never ending cycle 

As the market has continued to consolidate down to a few key players this has only sought to exacerbate the growing need for scale as the big players get bigger and the small get smaller. 

“The larger banks also have much more flow, and flow begets flow to a certain extent. They are able to improve their workflows and their hedging abilities with the more flow that they have,” concluded Jenkins.  

“It’s very difficult to play catch up; the big investment banks have already made large investments and significant developments in their equities platforms and they’re able to grow from that stronger footing.”