A third of the industry believe separating prop trading from other market making activities would do the most to improve investor confidence in equity markets, according to the results of the latest TRADE Poll.
When we put the TRADE Poll together last month – asking the question ‘What measure would do most to improve investor confidence in equity markets?’ – perhaps we should have offered the answer: ‘Anything that stops further embarrassing screw ups by the big banks’ because the parade of shame continued in July with Barclays (and others) caught manipulating LIBOR and Britain’s Financial Services Authority finding Barclays, HSBC, Lloyds and the Royal Bank of Scotland missold interest rate swaps to thousands of small businesses. The result has been that instead of increasing consumer confidence, most consumers think banking is a confidence trick.
In June’s poll, market sentiment essentially moved in a similar direction, with 33.3% of respondents voting that separating prop trading from other market making activities would do the most to improve investor confidence in equity markets.
Along with the third who wanted to separate prop trading, another 28.57% of respondents believed ring-fencing retail from investment banking was necessary to improve confidence. The issue, one market surveillance operator said, is one of trust and the separation of practices which the public find suspicious or too complex to understand.
“Inciting retail flow back to the market will only happen through improving market perception and confidence, and I question whether or not the industry is actively doing enough to improve the situation,” he said. “All we’re getting from regulators at the moment is talk. They are great at going out there and doing the PR bit, but when it comes the to nitty gritty, nothing is being improved.”
He contends that the FSA market surveillance system is flawed and the only way they can detect market manipulation is through market participants informing them about it.
“When you come to the banks, they do not want to put an industry standard forward, as that would be creating greater cost and ‘issues’ for them,” he said.
Benoit Lallemand, senior research analyst at Brussels-based public interest group Finance Watch, agreed the culprits undermining the confidence of long-term investors in the stock markets were improper mixes of flow – whether it be prop and market making, or retail and investment banking – but in his mind, all roads led back to the increasing obsession of exchanges with proprietary trading firms that engage in high-frequency trading (HFT).
Pointing to the structure of the stock markets, Lallemand suggested that since Europe’s exchanges had become privatised, they had moved away from the member-owned structures they once held, thus relinquishing their focus on providing valuable services to the real economy and instead concentrating their resources on winning profits from lucrative HFT business, at the expense of all other market participants.
“This makes a huge difference – despite representing only a couple of a per cent of the exchanges' customers, HFT is their main client base,” he said. “This is not in the interests of long-term investors. We need a market with all types of liquidity, not just a market that caters for a few. As it stands, the high-frequency traders are extremely damaging to investor confidence – they are driving people out of the market.”
In last month’s survey, 22.86% of respondents believed maker-taker venue pricing needed reforming. Lallemand believes the role of HFT firms as market makers should be re-examined. While old-fashioned market makers were subject to various constraints and obligations as part of agreements to provide liquidity, many current HFT market making firms do not sign such agreements and are not bound to provide firm quotes nor remain in the market.
“Market makers increase confidence in equity markets only when they have obligations and restraints,” added Lallemand. “HFT market makers make markets while also taking liquidity. There is a conflict of interest with these players who are supposed to serve you, but are actually combining that activity with predatory strategies that make a profit at your expense.”