The markets for trading securities in Europe are undergoing significant change as a result of business, technology and regulatory pressures, notes Robert Kay, managing director of TCA provider GSCS Information Services, in an industry report sponsored by NYFIX. "Opportunities for technology, marketing and administrative cost savings are prompting stock exchanges to consolidate through merger and acquisition," says the report. "In addition, the implementation of MiFID has explicitly encouraged the growth and extensive use of alternative trading venues in direct competition with the existing regulated exchanges," it continues.
The outcome and interaction of these trends is critically important for many market participants, including exchanges, brokers, dealers and independent entities that are directly involved in providing and using trading venues, as well as the technology companies that support them, according to the industry study. Asset managers, pension funds, investing individuals and corporations are also affected by MiFID.
"One key area of concern and interest for all parties is the extent to which liquidity in the trading of European equities fragments away from the primary exchanges on which the shares are listed," comments the report. "Based on our review of academic literature, analysis of the existing position and off-the-record discussions with a range of more than one hundred interested parties, our conclusion is that material fragmentation is both inevitable and in fact desirable," it says. Significant loss of market share will be experienced by existing stock exchanges to the extent that some may cease to exist, according to the report.
"Our conclusion may seem counterintuitive and certainly many existing exchanges believe that MiFID poses no serious threat to their trading business and profitability. We accept that stock exchanges have traditionally had a natural tendency towards monopoly in the area of trading venues for the securities they list. We further agree that there are, and will remain, significant policy advantages that accrue from having a monopoly or dominant provider in terms of market regulation and concentration of liquidity," comments the study.
Kay's conclusion that fragmentation is inevitable is based on several factors. "First, it needs to be recognised that off-exchange trading already accounts for between 15% and 20% of all trades by number and probably a higher proportion by value in markets, such as the U.K. and Germany, where stock exchanges do not enjoy regulatory monopoly positions," says Kay. This fragmentation will become more visible post-MiFID and its very visibility will encourage additional initiatives, he adds.
"In addition, MiFID clearly and unambiguously establishes a legislative and regulatory environment across Europe that encourages fragmentation because it is designed to foster competition. These factors in themselves do not form a sufficient basis for our conclusion. However, it is clear from discussions with market participants as well as the actions they have taken publicly, that the most important regulated exchanges (REs), multi-lateral trading facilities (MTFs) and systematic internalisers (SIs) have made, and are continuing to make, investments that will allow them to offer a range of highly competitive, differentiated and specifically tailored services to prompt utilisation of their services by their clients," explains Kay.
Access to algorithmic trading, DMA, smart order routing and market data aggregation technology will have to be improved if fragmentation is to come about. A number of leading investment banks and trading technology firms - including NYFIX - are making strides in this area, according to the report. "Their efforts, subject to cost considerations, will allow easy comparison of prices and aggregation of information about different execution venues. So individuals and institutions will have the tools they need to participate in the new venues without significant processing disadvantage," finds the report.
Given these factors, and assuming that clearing and settlement costs of venues are broadly comparable, then the existing level of fragmentation will increase, possibly quite dramatically, according to the industry study. "This will likely be to the detriment of existing exchanges, especially those that are peripheral in terms of underlying listings and/or unable to innovate and develop the technology and cost savings needed to compete," it concludes.