The buy-side will not benefit from the resurgence of the vertically-integrated exchange model, concluded respondents to April's poll on theTRADEnews.com, with half (50%) predicting increased trading costs for fund managers.
“The concern is that if there is a monopoly over post-trade operations it could increases costs,” said Martin Ekers, head trader at buy-side firm Northern Trust Global Investments. “A reduction in costs would be best served by interlinking settlement systems.”
By owning and operating platforms that provide trading, clearing and settlement services, exchange groups benefit from a broader base of income than trading alone. But this relies on the ability to retain captive flow throughout the transaction process. If interoperability permits choice at each stage in the chain, the value of the integrated model leaks away.
Debate over the merits of siloed and interoperable market infrastructure models is currently taking place in the European Parliament as it passes the European market infrastructure regulation (EMIR) into law. The legislation is intended to provide a framework for central clearing and risk mitigation of OTC derivatives, requirements for central counterparties, post-trade interoperability, reporting obligations and requirements for trade repositories.
If the parliament's Economic and Monetary Affairs Committee (ECON) recommends extending the rules to cover all derivatives, then clearing houses would be obliged to offer non-discriminatory rates for processing trades regardless of the execution venue. And if interoperability arrangements are allowed between cash equity clearing houses, as supported by ECON chair Sharon Bowles MEP, this would benefit independent clearing houses hoping to compete with siloed businesses based on cost. ECON will make its recommendations on 24 May, while the full parliament is expected to vote on EMIR in a plenary session in June.
Political risk
The merger of exchange operators Deutsche Börse and NYSE Euronext, proposed on 14 February, would make vertical integration a dominant model in Europe, as the German group's clearing and settlement capabilities would likely be extended across the combined firm's European operations, which would have had a 30.83% share of the region's equity trading in March 2011, according to data provider Thomson Reuters, making it the continent's largest exchange.
However Tony Nash, head of execution services at Execution Noble, the UK brokerage owned by Portugal's Banco Espirito Santo, believes the task of extending Deutsche Börse's model across markets would be highly complex. “Because of the fragmented nature of the European clearing model, it is unlikely that an exchange would be coordinated enough politically to offer a combined post-trade product,” he said. “It can work in a single country such as Germany but across Europe it is incredibly unlikely. You have to look at the associated risks on a sovereign level and a political level.”
“I wouldn't expect the merger to lower trading costs,” added Sören Steinert, head of trading, at Germany-based Quoniam Asset Management. “Stakeholders will no doubt ask the management to lower their internal costs and possibly even extend trading hours, but I don't think that fees have been looked at yet.”
It's in the post(-trade)
In theTRADEnews.com's April poll, 26% of respondents said that the wider application of siloed exchange models would have no significant effect on trading costs and Nash concurs.
“If there are gains to be made they are intra-country, not inter-country; but as domestic business is becoming a smaller part of the overall flow, a domestic silo wouldn’t have that much effect,” he said. “Even if the London Stock Exchange was to implement a single trading/clearing/settlement platform, I can’t see where the pressure would come from to lower costs.”
Noting the impact of trading venue competition on front-end costs, Ekers asserts that further reductions are most likely to flow from post-trade integration initiatives such as interlinking settlement systems. “If post-trade services could interoperate then prices would plummet,” he said.