Can you afford to ignore a quarter of all trading in European blue chips? According to index providers in Europe, you can.
Almost two and a half years since MiFID came into force, displayed multilateral trading facilities (MTFs) such as Chi-X and BATS Europe now account for roughly 25% of pan-European large-cap liquidity, according to data from Thomson Reuters. Yet those responsible for compiling Europe’s major indices still do not take this chunk of trading into account when compiling index values. European indices are currently calculated according to the last traded price of its constituents on the national exchange.
“An index is meant to give a fair reflection of market activity,” comments Alasdair Haynes, CEO of Chi-X Europe. “Price discovery happens on an MTF just as it does on a national exchange.” Haynes points out that Chi-X Europe often offers more liquidity in blue-chip stocks than the exchanges where they are listed.
For example, marketing company WPP Group traded 52.11% away from its primary listing venue, the London Stock Exchange (LSE), in the week ending 26 February, according to Fidessa Fragmentation Index, an analysis of on-order-book trading across Europe.
The price-forming role of MTFs has been the subject of intense debate since a series of exchange outages towards the end of last year. On 26 November 2009, trading on the London Stock Exchange was halted for three and a half hours following connectivity problems, while trading was suspended for three hours on SIX Swiss Exchange on 12 November. With no primary market trading in London and Zurich on parts of these days, the value of the UK and Swiss blue-chip indices, the FTSE 100 and SMI respectively, ceased to update, even though trading continued on alternative platforms.
Paul O’Donnell, chief operating officer at BATS Europe, suggests that the reluctance of index providers to include MTF volumes in index calculations presents a barrier to trading in such circumstances.
“If the market continues operating in the event of a primary exchange outage, traders should be able to see that and carry on trading,” he says. “It’s about being transparent to the market and ensuring that investors have a clear picture of what is happening.”
Index values are important for passive investment vehicles such as tracker funds and exchange-traded funds, instruments that are typically based on the value of an underlying index or basket of stocks, but are also used as an indication of when to make buy and sell decisions for brokers and buy-side traders.
“If you are a London-based investment firm that trades on MTFs and you use an index to benchmark a portfolio or make a passive investment, indices at the moment are not a true indication of your investment,” notes Charlotte Crosswell, president, Nasdaq OMX Europe. “Many firms in continental Europe still do not trade on alternative venues, and not including MTFs in indices gives them a reason to continue using only the primary exchange.”
Since MiFID’s introduction, MTFs’ share of European trading has steadily increased. In April 2008, six months after MiFID’s introduction, for instance, Deutsche Börse accounted for 94.8% of displayed trading in the German DAX index, according to Thomson Reuters. At the time, Chi-X Europe – which had been live for a year – was the only displayed alternative venue in operation. In February 2010, however, Deutsche Börse only accounted for 69.51% of DAX trading, with 30.49% executed across seven lit MTFs.
“MTF trade volume is consistently rising and the question now is; what is the tipping point?” says Bradley Duke, managing director, Knight Direct, the electronic trading division of agency brokerage Knight Capital.
Index providers’ apparent unwillingness to include MTFs in index calculations thus far is perhaps indicative of a broader need for change to suit an evolving pan-European environment.
“There are very few pan-European indices and many are updated very slowly – once every 15 seconds,” adds Haynes. “There will be a greater move toward pan-European indexing, but the real issue is that many indices are owned and controlled by national exchanges themselves. There is now a sufficient level of competition for equities in Europe that needs to be reflected in index pricing.”
One of the most widely-used pan-European indices, the Euro STOXX 50, is jointly owned by Deutsche Börse and SIX Swiss Exchange, but MSCI Barra also offers a variety of pan-European indices. At a national level, exchanges also have a role in index provision. FTSE, the global index provider most famous for its FTSE 100 index of leading London-listed stocks, is an independent company jointly owned by the Financial Times and the London Stock Exchange, while Nasdaq OMX is responsible for the indices in Stockholm, Helsinki and Copenhagen.
Next week: The case against inclusion
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