Leading pan-European multilateral trading facilities (MTFs) have codified the responsibilities of market makers to ensure a harmonised approach to the ban on short selling bank stocks introduced by a number of European countries in mid-August.
Chi-X Europe, BATS Europe and Turquoise have devised a consistent framework for applying the ban, which exempts firms contracted to provide liquidity to a particular exchange or trading venue. The initiative will allow market participants that meet liquidity provider criteria on MTFs to short financial stocks despite the ban – just like qualified market makers on domestic European bourses in affected countries.
“Individual country regulators put out individual notices related to the short-selling restrictions, so we wanted to ensure we were interpreting those on a consistent basis,” Mark Hemsley, CEO, BATS Europe, told theTRADEnews.com. “It is sensible for the MTFs to work together as we have many of the same customers that could be considered as liquidity providers.”
Last week, the short-sale ban implemented on 12 August by authorities in Belgium, France, Greece, Italy and Spain was extended by at least another month. At the end of September, the five regulators will meet to discuss when to lift the ban, which applies to any transaction –cash, listed or OTC derivative – which creates or increases a net short position, even intraday. NYSE Euronext operates the French and Belgian stock markets, Spain’s stock markets are run by Bolsas y Mercados EspaÃ±oles, the London Stock Exchange Group owns Borsa Italiana, while Greece’s Athens Stock Exchange is a subsidiary of the Hellenic Exchanges Group.
According to notices on all three of MTFs’ websites, liquidity providers will be defined according to their trading activity in EURO STOXX 50 securities. This includes an obligation to provide liquidity for all of the index’s constituents for 80% of the time, with spreads no larger than 25 basis points and an aggregated quoted volume of €5,000 within the acceptable spread. BATS Europe lists the firms providing liquidity in French stocks as Virtu Financial, GETCO Europe and Hudson River Trading.
A number of MTFs include electronic market-making firms, which provide liquidity using high-frequency trading strategies, among their key liquidity providers and shareholders. Chi-X Europe – which is current awaiting sign off to merge with BATS Europe by the UK’s Competition Authority – lists GETCO Europe, Citadel and Tibra Trading among the electronic market makers on its platform. Both BATS and Chi-X are part-owned by electronic market makers, but Turquoise is owned by the London Stock Exchange Group with minority stakes held by brokers.
The initial short-selling ban primarily covered financial stocks following intense speculation during the turbulent market conditions in the first two weeks of August. The ban requires trading venues to define the criteria that providers of liquidity would be subject to so that they could continue to short stocks. Short selling is a key component of many market-making strategies as it allows firms to hedge the risks associated with providing liquidity.
According to a spokesperson for Chi-X Europe, although the short-selling ban acted as the impetus for the MTFs to join forces and place contractual obligations on providers of liquidity, longer-term considerations were also a factor.
“There was a demand from clients for us to recognise and codify the obligations for liquidity providers,” said the spokesperson. “The contracts will ensure that these firms continue to provide liquidity during volatile periods, as well as clarifying their activities to the European regulators.”
Contractual obligations for providers of liquidity are already required by a number of domestic stock exchanges, which typically include a larger proportion of liquidity providers from the traditional institutional brokerage community than MTFs. Liquidity providers for French and Belgian stocks on NYSE Euronext include Societe Generale, BNP Paribas, Oddo and Cie, Timber Hill and RBS.
The bourse differentiates between permanent and auction liquidity providers. To become a liquidity provider on NYSE Euronext, firms must commit to maintaining a specific size and spread in each stock, which is judged by the exchange group based on prevailing liquidity in the same or similar stocks in its central order book.
In April 2011, NYSE Euronext launched a supplemental liquidity provider programme to boost liquidity in blue-chip stocks. To qualify, firms are required to preserve a presence on both sides of the order book for a specific basket of stocks for at least 95% of continuous trading; offer a minimum order size of €5,000, with prices based on a NYSE Euronext-derived best bid or offer for at least 10% of the time.
The issue of placing minimum obligations for liquidity providers has recently gained prominence, not least due to the ongoing debate surround high-frequency trading.
During the 6 May 2010 flash crash, when a rogue algorithmic order caused US markets to briefly plummet before rebounding just as quickly, electronic market makers were criticised for apparently ceasing to offer liquidity during the market stress.
The MiFID consultation issued by the European Commission in December 2010 suggested that high-frequency traders should continue “providing liquidity in financial instruments on an ongoing basis subject to similar conditions that apply to market makers”. The paper also suggested minimum resting periods for quotes and/or an order-to-transaction ratio.