While signs of recovery from the financial crisis may provide some respite to liquidity-deprived equity traders, new regulation could result in yet another dramatic shift to the trading landscape in 2010.
In 2009, equity values and volumes in the US and Europe suffered from the decline in company valuations, the flight of investors from equities to asset classes considered less risky, and the fall of currency values.
But 2010 is likely to be a different story as global economies start to recover.
“Many long-only houses kept a lot of cash on the sidelines last year, but as the macroeconomic situation improves, there will be more cash transferred into securities in those countries emerging out of the recession in 2010,” comments Daniel Garrod, analyst with Citi’s diversified financials team. “A healthier pipeline of IPOs, a pick-up in M&A activity and a reallocation back to hedge funds, which are now seeing more positive inflows and a recovery in performance, will all contribute to more vibrant equity activity this year.”
Garrod predicts a switch from low-risk corporate bonds, which were favoured by investors last year, to equities, and a broadening of risk within all asset classes by both institutional and retail investors. He’s not alone. According to a survey of 200 equity strategists conducted by Thomson Reuters, the FTSE 100 is estimated to end 2010 9.7% higher than its value of 5412.9 at start of the year, while the S&P 500, which ended 2009 at 1,115.1, is expected to rise 9% this year.
Turnover in January suggests the markets have already turned a corner. In Europe, the return to equities has already benefited multilateral trading facilities BATS Europe and Chi-X Europe, which have both reported strong starts to the year. BATS Europe recorded a record one-day turnover of €1.8 billion on its displayed order book on 20 January, while Chi-X Europe overtook global exchange group NYSE Euronext in terms of pan-European market share for the first time on 19 January, accounting for 16.81% pan-European market share, compared to NYSE Euronext’s 15.59%.
BATS Europe CEO Mark Hemsley believes the trend will continue and forecasts a 15% rise in volumes and values of European trading by the end of 2010.
However, the equity revival may be influenced – both positively and negatively – by the prospect of various regulatory proposals, such as potential curbs to high-frequency trading in the US and Europe, and increased interoperability of central counterparties (CCPs) in Europe.
Last week, US president Barack Obama raised the prospect of circumscribing proprietary trading by banks in a bid to control excessive risk taking, which could reduce equity flow.
In addition, US regulator the Securities and Exchange Commission (SEC) is conducting a widespread review of equity market structure. The SEC has already proposed a ban on naked sponsored access, which currently allows a broker’s client to trade directly on a trading venue using a broker’s ID with no day-to-day risk checks. The regulator’s planned abolition of flash orders is likely to have a bigger impact on high-frequency traders than other market participants.
Naked sponsored access is estimated to account for 38% of daily US equity flow according to a report from consultancy Aite Group. High-frequency is commonly believed to account for two-thirds of equity volume in the US and around 40% of flow in Europe.
In the UK, prime minister Gordon Brown has mooted the idea of a Tobin tax, a small fee levied on financial transactions such as share trading. This type of tax would be extremely significant for high-frequency and stat-arb traders, which send a large amount of orders to trading venues with the aim of collecting small profits on each transaction.
“High-frequency trading will increase its penetration of the European equities market in 2010, which will drive volumes higher, but there is the spectre of regulation hanging over it,” said Simmy Grewal, European analyst at Aite Group. “If there is something similar to a transaction tax in the UK, high-frequency trading would die and so would the volumes it provides to the market.”
Greater CCP interoperability however, could lead to an increase in equity volumes because they would give traders more choice when clearing and settling European equities trades. Given the slow progress on interoperability in Europe since MiFID, the topic is likely to be tackled in a new clearing and settlement directive due to be introduced by the European Commission this year.
Currently, certain algorithmic trading strategies that divide orders between as many trading venues as possible to minimise market impact can not be used in Europe because of the high costs incurred from using multiple CCP. Interoperability would enable the buy-side to consolidate all executions in specific stocks to one clearing house, thus reducing costs and improving algorithmic efficiency.
“Although electronic trading has led to a decrease of direct execution costs, there are higher frictional costs related to clearing and settlement since MiFID,” said Grewal. “If interoperability is introduced in 2010, post-trade costs would fall, which is sure to buoy the electronic trading market.”
The recovery may be underway, but regulators may have the final say on the path of the equity markets in 2010.
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